Is the Tesco share price a bargain or should I buy this 10% dividend stock?

Supermarket aisle with empty green trolley
Supermarket aisle with empty green trolley

The Tesco (LSE: TSCO) share price has fallen by 25% from the 266p high seen in August. If you’re holding the shares, this may seem like bad news. But, as I’ll explain today, I think this fall could be a buying opportunity for long-term investors.

Growth remains strong

When Tesco’s half-year results triggered a sell-off in October, my verdict was that “today’s dip could be a buying opportunity.”

Group sales rose by 12.8% to £28.3bn during the first half of the year, helped by a 3.8% increase in like-for-like sales in the UK and Ireland. Underlying operating profit rose by 24% to £933m, as profit margins improved, and wholesaler Booker made its first contribution.

Excluding the discontinued Tesco Direct business, the group’s operating margin rose by 0.3% to 3.02% during the first half. This suggests to me that chief executive Dave Lewis is on track to hit his target margin of 3.5-4% in the 2019/20 financial year.

The shares look cheap to me

During the summer, I’d have said that Tesco stock looked fully priced. But the selloff we’ve seen since then has made the shares look much better value, in my view.

Analysts expect the supermarket’s adjusted earnings per share to rise by about 20% this year, and by a further 20% in 2019/20. These forecasts place the shares on a 2018/19 forecast P/E of 14, falling to a P/E of 11.7 in 2019/20.

A lower share price means a higher dividend yield. Forecast figures for this year give a yield of 2.6%, rising to 3.8% next year.

Tesco’s dividend payout is still returning to normal, and the yield is rising fast. If you’re building a long-term income portfolio, I think now could be the perfect time to buy.

47,870 convenience stores

As I write, payment handling company PayPoint (LSE: PAY) is Thursday’s top riser. The £540m firm’s share price is up by more than 7%, following a strong set of half-year results.

PayPoint operates a network of payment terminals in convenience stores. The firm’s systems handle transactions such as cash bill payments, phone top-ups and card payments. It also operates the Collect+ parcel drop-off network, while new functionality being rolled out currently will allow retailers to place orders directly with wholesalers such as Booker.

PayPoint terminals were present in 28,886 retailers in the UK and Ireland at the end of September. The company also has a network of 18,984 retailers in Romania, where cash is still more widely used for bill payments.

A 10% yield I couldn’t ignore

The company’s preferred measure of revenue excludes pass-through costs, such as mobile phone top ups. This net revenue figure fell by 1.6% to £55.6m during the six months to 30 September.

However, lower costs helped to increase operating profit by 4.5% to £25.5m. This lifted the group’s underlying operating margin to 45.8%. Such high margins mean cash generation is very strong and shareholders enjoying generous dividends.

PayPoint is expected to pay a total dividend of 84p per share this year, giving the stock a yield of about 10%. However, some of this has been funded by cash received from the sale of two non-core businesses in 2016.

Stripping out these special dividends, I expect the shares to offer a yield of about 6% next year. But if cash generation remains strong, shareholders could enjoy further top-up payouts. I remain a buyer at current levels.

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Roland Head owns shares of PayPoint. The Motley Fool UK owns shares of PayPoint. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.