Many investors would have seen the writing on the wall when Tesco slashed its dividend by 75% to 1.16p the other week. The bad news has been coming in for a while, and I’m not just referring to the horsemeat scandal.
The firm managed to issue two profit warnings this summer, and also ousted its former CEO - Philip Clarke - against the backdrop of price competition with discounters such as Aldi and Lidl. The company now trades at 229.3p - its lowest price since 2003. How the mighty have fallen.
It is impossible to predict where Tesco will go from here, but there were several signs that the a dividend cut was just around the corner. In our eBook “How to Make Money in Dividend Stocks” - essential reading for dividend investors - we discuss how a range of Momentum and Quality metrics can help investors avoid ‘dividend traps’. Here we look at how they could have been applied to Tesco.
1. Share price momentum: Before the dividend cut, Tesco’s Dividend Yield was a very high 6.3%. This may have looked attractive at face value, but investors should have been cautious as the apparently compelling yield was actually the result of a substantial freefall in the share price. Momentum has a tendency to persist in the stockmarket both on the upside and the downside - Tesco has underperformed the market by 41% this year and its share price has fallen by 37% since September 2013. It looked set to continue.
2. Dividend Cover: Many analysts see the Dividend Cover as the essential dividend health metric. The ratio gives an indication on how much a company is paying out in dividends in relation to the earnings it is generating. The higher the ratio, the better. A company with a lower ratio is paying paying out a larger proportion of its profits in the form of dividends. The usual rule of thumb is that a dividend cover of more than 2x is viewed as healthy. Prior to the dividend cut, Tesco’s Dividend Cover was 1.6x, which was lower than Sainsbury (2.1x: TTM), M&S (1.9x) and Wal-Mart (2.5x). The only major grocer with a lower Dividend Cover was Morrisons (-0.8).
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