There’s a growing chorus of voices predicting a further rally for US stocks in November and beyond. And wherever the US market goes, UK stocks often follow.

Bullish commentators over the past few days include CNBC’s Jim Cramer, analysts at JP Morgan, and analysts at Bank of America. But there are still some bearish voices out there too, such as BlackRock‘s chief investment strategist. 

October was positive

To put things in context, we’ve already seen a strong rally for US stocks during October. The Dow Jones Industrial Average gained almost 14% to score its best month since 1976. And the S&P 500 increased by around 8% in October.

Here in the UK, the FTSE 100 delivered an increase of around 3% last month and the FTSE 250 mid-cap index rose by just over 4%. But many individual UK stocks have done even better than that. However, not all of them have risen.

Jim Cramer thinks that technical charts are indicating there is further potential for increases this year.  However, I’d be the first to admit that relying on charts as a guide is perhaps not the best way to proceed. A better approach for me is to analyze the fundamentals and valuations of businesses.

Nevertheless, Cramer has been following renowned US technical analyst Larry Williams. And Williams apparently used charts to predict the rally in October. According to Cramer, Williams reckons the market is likely to deliver more upside through to the end of the year.

“Bulls be prepared, bears beware,” said Cramer on his popular TV show. And I can see that the period heading into Christmas and the New Year has often produced bullish sentiment among investors in previous years.

Inflation and interest rates

Meanwhile, most of the optimistic commentators have been focusing on an expectation that inflation will ease soon, causing central banks to back-off from aggressive raising of interest rates. And investors have more money in cash than at any time over the past couple of decades, apparently. So, the theory goes, improving general economic conditions could cause a flood of money back into stocks and shares thus prompting a sustained rally.

Bearish voices have been saying things like the markets have already gone too far too fast. And the reality of a global recession will likely take stocks and shares lower.

However, none of these opinions should make any difference to my investment programme in shares. I’m concentrating on the prospects, valuations, and quality of the businesses underlying the shares that interest me. If those things add up to an attractive long-term investment opportunity, I’m pulling the trigger and buying. And that’s regardless of whether the general stock market moves up, down, or sideways.

Meanwhile, today’s weaker stock market offers an opportunity if I focus on the long term. After all, billionaire investor Warren Buffett once said, “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down”.

More reading

Bank of America is an advertising partner of The Ascent, a Motley Fool company. Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

With the Capita share price near 25p, it’s dropped by around 47% over the past year.

In fairness, the markets have been terrible and many stocks have plunged. But the business has perhaps earned the poor performance of its shares. Nevertheless, it has turnaround potential now. And I think the opportunity is worth me exploring.

Rapid rise and fall

Capita was the UK’s leading player in creating and developing the outsourcing market. And the business grew at lightning speed after emerging as a standalone company back in the late 1980s. And it diversified its services both wide and deep in the public and private sectors.

Capita seemed to be everywhere. For example, it’s had contracts such as the running of the London congestion charging zone. It’s collected the BBC licence fee, and provided electronic tags for offenders. It’s recruited for the British Army and for the NHS. And it’s been involved in many primary support services for the NHS as well as many other diverse operations in both the public and private sectors.  

The share was a darling of the stock market — until it wasn’t. The company’s rapid expansion into a mind-bogglingly wide spread of services caused an apparent lack of focus. Contracts started becoming unprofitable. And worse still, Capita started mucking things up and getting things wrong with many of the services it was supposed to provide.

The day of reckoning came in July 2015 when the share price topped-out at around 800p. And that’s a lot higher than today’s 25p, which goes a long way towards telling the story of the decline of the business. Indeed, the earnings record over the past few years has been terrible. In 2016, the company posted annual earnings of just over 14p per share. But for 2022, City analysts expect a little under 4p.

Turnaround and debts

One of the outcomes of Capita’s history of ascendancy and decline is a huge pile of debt. It’s a big problem facing the current management team in their efforts to turn the business around. And the company is addressing it in part with a programme of asset sales.

One recent example is the announcement of the company’s intention to dispose of its Pay360 Limited business. And it also completed the sale of its two real estate and infrastructure consultancy businesses in September. All the money raised appears to be going towards debt reduction.

In August’s half-year results report, chief executive Jon Lewis said the company’s reputation for delivery and digital transformation services is increasing. And it’s secured “a series of important contract wins and renewals”. Meanwhile, City analysts predict an increase in earnings of around 34% in 2023 making the forward-looking earnings multiple about five.

Rising annual earnings haven’t been seen for around five years. So, this could be the beginning of a meaningful turnaround. But it’s early days. And the company has a lot of historical ‘baggage’ and debt to shift. Meanwhile, there’s no shareholder dividend.

I don’t think the Capita share price is a particular bargain when adjusting for the company’s debts. The valuation looks fair to me. And the company has much still to prove. So I’m watching from the sidelines for the time being.

More reading

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

For me, recent market weakness makes it a good time to target passive income from dividend-paying shares. And if I had spare cash I’d buy some more.

For example, I like the look of Moneysupermarket.Com (LSE: MONY). The company operates price comparison websites for insurance, money, home services and other products.

On 18 October, the third-quarter update showed 15% growth in revenue and 6% for the year so far. And as with many businesses, such a positive performance disagrees with the fallen share price.

Ahead of expectations

The directors said the outcome was “ahead of expectations”. And they predict full-year earnings before interest, tax, depreciation and amortisation (EBITDA) will likely come in “towards the upper end of market expectations”.

I see this enterprise as a ‘cash cow’ rather than a growth proposition. And that reflects in the record of steady shareholder dividend payments. Indeed, payments continued even through the pandemic. 

There’s competition in the sector. And that could threaten the progress of the business in the years ahead. However, this is a well-established brand. And that will be hard to replicate for would-be challengers.

Meanwhile, with the share price in the ballpark of 178p, the forward-looking dividend yield is around 6.8% for 2023. I think the stock could make a useful addition to my diversified portfolio.

But I’m also keen on DS Smith (LSE: SMDS). The firm provides sustainable packaging solutions, paper products and recycling services worldwide.

Very good trading

On 10 October, Smith surprised the market with an upbeat trading statement. Performance had been “very good” and the directors said they expect full-year trading to April 2023 to be “ahead of expectations”.

The company skipped dividend payments in the depths of the pandemic. But cash flow held up well. And, since then, the company has made payments and they are set to rise. 

Smith faces competition in the sector, and there’s quite a bit of debt on the balance sheet. Those factors could make life difficult for the business in any severe economic turndown.

Nevertheless, I’d embrace the risks to include this stock in my portfolio. And with the share price around 290p, the forward-looking dividend yield is about 6% for the trading year to April 2024. 

I’d also go for National Grid (LSE: NG), the operator of energy transmission and distribution systems in the UK and the US.

Steady operational progress

On 10 October, the company delivered its pre-close update. And trading had been “in line” with directors’ expectations. We’ll find out more with the interim report due on 10 November.

I think the firm occupies a well-defended niche within the power systems at home and abroad. But there is a lot of debt on the balance sheet. Although that’s not unusual for utility companies that need to plough a lot of capital into maintaining and improving networks.

However, rising interest rates and regulatory demands could make it difficult for the company to keep up its shareholder dividend payment in the future. Nevertheless, the multi-year dividend record is robust. And I’d embrace the risks and aim to hold this stock for the long term.

With the share price near 940p, the forward-looking yield is near 6% for the trading year to March 2024. And that’s attractive to me.

More reading

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended DS Smith and Moneysupermarket.com. 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.

I think it’s a great time to buy FTSE 100 shares to hold for the long term. The general economic and geopolitical news has been gloomy for a protracted period now. And company valuations have been driven down in many cases.

But lots of companies keep releasing positive trading updates. And many businesses are paying generous-looking shareholder dividends and buying back their own shares. I think the situation speaks volumes about the resilience of incoming cash flows.

One day, investor sentiment will turn more positive. And that could drive share prices higher. On top of that, I expect ongoing operational performance to lift company earnings for years to come. Nothing is certain, but valuations may not look as attractive as they do now in the months and years ahead.

I’ve been buying some of these decent-looking FTSE 100 stocks. But I don’t have enough spare cash to buy every opportunity I see. Nevertheless, plenty of shares now inhabit either my portfolio or my watchlist.

Connecting Africa

For example, I like the look of Airtel Africa (LSE: AAF). The company is rolling out telecommunications and mobile money services across the African continent. And recently-announced radio spectrum acquisitions in Tanzania and Zambia prove growth is on the company’s agenda.

We’ll find out more about operational progress with the half-year report due on 27 October. Meanwhile, with the share price near 125p, the forward-looking dividend yield is around 6% for the trading year to March 2024.

It’s possible that a general economic slowdown in Africa could affect earnings ahead. And the company carries quite a bit of debt. Nevertheless, debt reduction appears to be a priority with the directors. And I bought a few of the company’s shares to hold for the long term as the growth story unfolds in the years ahead.

Energy infrastructure

I also like National Grid (LSE: NG), the electricity transmission and distribution company with operations in the UK and the US. Over many years, the business has been a steady payer of shareholder dividends.

But lately, the share price has dipped lower. And I reckon that move could be linked to rising interest rates. Indeed, National Grid has had a big pile of debt for as long as I can remember. And when interest rates rise, it could become harder for the business to service its interest payments and shareholder dividends.

However, National Grid isn’t the only company in the utilities sector to suffer from this challenge. High debts tend to be an outcome for businesses that always need to invest vast sums to maintain operations.

Nevertheless, I’m optimistic that interest rates won’t rise much further than they have already. And City analysts are not predicting any dividend cuts ahead for the company. In fact, they’ve pencilled in mid-single-digit percentage rises in the shareholder payment. And that’s for the current year to March 2023 and for the year following.

Meanwhile, with the share price near 919p, the forward-looking yield for next year is running at just above 6%. I think that’s attractive and I’d aim to buy some of the shares to hold for the long term in my diversified stock portfolio.

More reading

Kevin Godbold owns shares in Airtel Africa Plc. The Motley Fool UK has recommended Airtel Africa Plc. 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.

The Avacta (LSE: AVCT) share price burst into life during the spring of 2020. And the share shot up from around 15p in March 2020 to 275p in March 2021 — wow!

The clinical stage biopharmaceutical business was a true Covid share. In 2020, it started developing rapid tests for the coronavirus infection. And the company proved to be good at releasing exciting-sounding updates via the Regulatory News Service (RNS).

A speculative frenzy

The news stream through 2020 details every step in the company’s operational progress. I think the stock probably became caught up in a speculative frenzy powered by locked-down investors and speculators with time and money on their hands.

Alas, in April 2021 Avacta released its full-year results report for 2020. And the financial figures proved to be less euphoric. Revenue for the year came in at a mere £2.1m or so, and the business generated an operating loss of just under £19m. However, the company did manage to use all the investor interest to raise much-needed capital of just under £54m.

Within a few weeks, the stock began to slide and kept on falling. Indeed, a fair bit of the speculative froth dropped away from the price until it bottomed in March 2022 near 41p. But the full-year results for 2021 didn’t offer reassuring figures for sharholders. Revenue for the year was a little over just £2.9m, while operating losses had ballooned to around £29m.

I might have assumed that the end of the story would be predictable. Perhaps it would have run along the lines of an ever-falling share price. And that would likely have been accompanied by escalating losses and an ongoing series of fund-raising events of decreasing size. Certainly that template has been well-established by prior loss-making outfits.

A resurgent share price

However, by April this year, the share price had shot back up to above 140p. Perhaps the move had been driven by chief executive Dr Alastair Smith’s positive comments in the full-year report. He said he’s “confident and excited” about the immediate and long-term prospects of the business.

For example, he pointed to the potential of clinical trial progress for the firm’s AVA6000 project. And he also emphasised the firm’s pipeline of in-vitro diagnostics (IVD) products and a redeveloped SARS-CoV-2 antigen test “offering immediate and long-term opportunities”.

Most recently, the company has been raising money to buy Launch Diagnostics, a distributor in the UK IVD market. The company reckons the acquisition will accelerate Avacta’s diagnostics strategy. It’s “the first step” in a drive towards building an integrated and differentiated IVD business “with global reach” the directors said.

More losses ahead

That sounds promising. But the financial reality of the move is yet more dilution for existing shareholders. It’s all jam-tomorrow stuff again. And City analysts don’t look as optimistic, to me. They’ve pencilled in a net loss of just over £30m for 2023.

With the share price near 102p, as I write, it’s down around 14% over the past year after a roller-coaster ride. It’s possible the business could realise its ambitions profitably in the years ahead. But I see the stock as highly speculative. And I don’t think it can make me rich. So I’m avoiding it.

More reading

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

I think the markets are presenting one of the best opportunities ever to aim for a million from stocks and shares. In many cases, share prices are on the floor. But their underlying businesses are not.

And I’m not alone in my optimism. John Guerard is the director of quantitative research at McKinley Capital Management. And, according to Barron’s, he recently said his firm is “confident” returns from many stocks and shares will be “substantial” over the next three-to-five years.

Good underlying business trading

To me, that view makes sense. And that’s because it looks like share prices are understating the value of many businesses right now. Shares could rally to better reflect the true worth of businesses when the economic doom and gloom starts to lift.

But I’d go further. I think a rally in stocks and shares could gather even more momentum in the coming years. And that’s because businesses could make decent operational progress if general economic conditions become more benign going forward.

My guess is things will get better. It’s often darkest just before the dawn. And that’s why it can be a good idea to buy stocks and shares when things look bleak. 

Meanwhile, one positive and upbeat company report seems to follow hard on the heels of another. And in many cases, the strong trading experienced by businesses is surprising the market. For example, there has been recent positive trading news from companies such as information provider Relx, packaging and paper specialist Mondi, and homewares retailer Dunelm, among many others.

So I’d aim for a million right now by working hard on my watchlist of companies. I’d look for a strong balance sheet, good quality indicators and a runway for earnings growth. And the final requirement would be a valuation that can make sense of a long-term investment in a company’s shares. And with all the pessimism hanging over the markets right now, there is plenty of good value around.

Research and stock-picking

Good stock-picking is key to my plan. But, realistically, it’s unlikely I’d be able to turn £30k into a million in Guerard’s timetable of three to five years. However, I don’t have to because another key part of my plan is to invest for the long term.

As an illustration, I could aim to match billionaire investor Warren Buffett’s record of compounding average annual returns of 20%. And if I did that, it would take around 20 years to hit the magic million. 

However, positive returns from stocks and shares are not certain or guaranteed. And I could even lose money over time if I happen to pick businesses that develop operational problems.

Nevertheless, even lesser rates of annual return are worth compounding. And the risks that come with shares aren’t going to stop me trying to invest well and aim for a million pound portfolio.

More reading

Kevin Godbold owns shares in Dunelm Group. The Motley Fool UK has recommended RELX. 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.

Rolls-Royce (LSE: RR) shares have been on a downtrend since November last year. With the stock near 73p, its plunged by around 47% over the past 12 months.

That wasn’t supposed to happen! The reasons for the company’s troubles during the pandemic have been well reported. But the partial recovery in airline flying hours should have propelled the business well along the runway to recovery. 

And the way the company has been selling non-core operations to shore up it’s debt-laden balance sheet should have provided added impetus for the shares.

The business isn’t the stock

The problem for shareholders is that the business isn’t the stock. Rolls-Royce the business has been on a fast-recovering trajectory. City analysts forecast chunky triple-digit-percentage increases in earnings this year and next. Revenue is on the rise too. And operating cash flow has recently dragged itself out of negative territory.

However, the background to those positive figures is that Rolls-Royce has proved it relies on the health of the airline industry. And that’s a vulnerable and cyclical sector. But on top of that, the company carries a lot of debt. The business was making a loss in the two years before the pandemic even started. And I think that speaks volumes about the complexities — and costs — of the engineering industry.

If I was starting a business from scratch, or buying one outright, it wouldn’t be an engineering enterprise. There are easier ways to make money. And if I’d never heard of Rolls-Royce before, I wouldn’t consider buying the shares today, based on the current trading and valuation figures.

For example, the company currently pays no shareholder dividend. City analysts are forecasting a big recovery in earnings, true. But even after the recent slide in the share price, the advance is more than priced-in. The forward-looking earnings multiple for 2023 is just over 19. And I think that valuation looks full and well up with events. 

Potential for higher earnings ahead

But the firm’s quality indicators don’t look so good either. The profit margin is running below 3% and the return against invested capital below 5%. If I’d happened to find this company on my screens by chance, I’d have likely moved on to examine the next opportunity.

However, flying hours in the airline industry are still at just around 60% of their pre-pandemic levels. So, theoretically, there’s potential for an increase of just under 67% to get back to the 100% capacity from 2019. And if the industry does fully recover, Roll-Royce could see its revenue and cash flows increase. Potentially, net profits could receive a significant boost.

Nevertheless, Rolls-Royce shares are not for me today. And that’s because I see stock opportunities that look better to me right now. For example, in the same industrials sector, I like the look of IMI. The business engineers and manufactures products that control the precise movement of fluids.

There are no guarantees of a positive performance from an investment in IMI shares. But the company delivered an upbeat trading statement at the end of July. It also has some impressive quality metrics. And the balance sheet features far less debt than Rolls-Royce’s. I’m thinking about buying it.

More reading

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

After all the recent weakness in the markets, it could be a great time to pick growth shares to hold for the long term. On top of that, cyclical businesses can produce decent capital growth for stock investors when coming out of a downturn.

In his book Beyond The Zulu Principle, legendary investor Jim Slater wrote in praise of the cyclicals. He said in some years, cyclicals outperform growth shares “by a wide margin”. However, the tricky part of investing in cyclicals is the timing.

There could be better conditions ahead

Perhaps I’m mad to be considering the cyclical companies now alongside potential growth share investments. They’ve been under pressure for months. And Slater pointed out that cyclical businesses tend to fare worse when interest rates are rising.

But I think the recent rises in interest rates have done much to push cyclical stocks lower. And one of the key tactics, as I see it, is to pick cyclical stocks when they are near the bottom of a cycle. But, of course, that’s easier said than done.

However, the stock market looks ahead. And I reckon interest rates will top-out and begin to ease in the months ahead. One thing that could put downward pressure on interest rates is a weak economy. And that could be especially true if inflation starts to fall.

Slater said the best time to invest in cyclicals is when interest rates are falling and when the value of the pound sterling is rising. And my guess is we could soon see both those conditions. In fact, since bottoming in late September, the value of the pound against both the US dollar and the euro has been trending higher.

Robust company results

But trying to read the financial markets like that is as good as reading the tealeaves in the bottom of my cup. The main driver of my decision to include fallen cyclicals alongside growth shares is that they look to me as if they have found the bottom. Not in all cases. But many bombed-out cyclical shares are backed by businesses that have been delivering robust trading statements.

I’m bullish about the economy, businesses and UK shares for the medium to long term. And, therefore, I’m prepared to embrace the risks of share ownership now.

For example, I like the look of Somero Enterprises. The business designs and makes concrete levelling, contouring, and placing equipment worldwide. And strategic engineering and environmental consultancy business Ricardo has caught my eye. As has social housing energy services company Sureserve.

There’s no guarantee that investing in these three companies now will produce a positive long-term outcome in my portfolio. And Slater cautioned that “all companies do better when the economy is prospering and find the going tough when it’s in the doldrums.”

Nevertheless, I’m looking beyond short-term difficulties in the economy and in the markets and investing for the long term. I already hold Somero shares and am considering the others.

More reading

Kevin Godbold owns shares in Somero Enterprises, Inc. The Motley Fool UK has recommended Somero Enterprises, Inc. 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.

The economic and geopolitical news has been gloomy for months now. And the stock market has been weak. 

Day after day, many investors have been watching the value of their share portfolios grind lower. However, falling markets keep sliding until one day, they don’t. And my feeling is that day is close.

The bull follows the bear

Meanwhile, bear markets tend to set up the conditions for the next bull run. And one reason for that is the way better value can emerge from pummelled stocks. A bear phase can scour a lot of speculative froth from company valuations. And that means it may be easier for investors to find attractive stocks offering a margin of safety.

And in the past super-investors such as Benjamin Graham and Warren Buffett have used the concept of a margin of safety to good effect. The idea is to buy stocks when they are assigning a value to underlying businesses below what they are actually worth.

However, I admit it’s not easy to pin down the true worth of any enterprise. And doing so can demand the application of a blend of art, science and arithmetic. Investing is all about looking into the future and playing the balance of probabilities.

But investing from a good-value base is a sound start. And I reckon many companies with beaten-down stock prices have been surprising the market with positive trading updates. For example, we’ve seen recent upbeat statements from companies such as Shoe Zone, Somero Enterprises, Capital, and Quixant, among others.

I reckon good trading bolsters the true worth of a business and adds weight to the idea that the market could be undervalueing many companies right now. But that’s not the only reason I reckon we could be about to see the great stock market recovery of 2022 and beyond.

The stock market looks ahead

Another reason I’m bullish is because many commodity prices have been falling over recent weeks. And expensive raw materials have previously been one of the drivers of cost inflation in the economy. However, commodity prices could be falling because speculators are predicting a further slowdown in the economy. 

But is an economic slowdown such a bad thing? If economic activity declines, it could encourage central banks to lower interest rates. And that’s especially true if the rate of inflation begins to fall as I expect it will.

Meanwhile, it’s worth me remembering that the stock market is not the economy. And the markets are known for looking ahead. Therefore, a scenario with falling interest rates could be a booster for many businesses. And their stocks could elevate from the lowly positions they currently occupy.

I think it’s such forces that cause new bull markets to begin when many people least expect them to. When, for example, the news is grim and when everyone seems pessimistic.

It’s possible the markets could become more optimistic as we approach the end of the year and the festive season. Although nothing is certain with stocks and shares. And I could easily prove to be wrong in my assumptions. Nevertheless, I’m investing now and working hard on my watchlist to identify more stock opportunities.

More reading

Kevin Godbold has positions in Capital Limited, Quixant, Somero Enterprises and Shoe Zone. The Motley Fool UK has no position in any of the shares mentioned. 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.

The Tesco (LSE: TSCO) share price is down. But does the company now make a good stock investment? The directors seem to think so. Some of them have been buying the shares for themselves in October. And I don’t blame them.

Cash flow holding up

A year ago, Tesco made a big statement about the value it sees in its own business by starting a Â£750m share buyback programme. I reckon the move demonstrates that a healthy flow of cash is still coming into the business. And strong cash flow is one of the main reasons I’d consider buying some Tesco shares. It takes cash to pay shareholder dividends. And, to me, an investment in the company is all about dividend income. 

But previously, the biggest requirement for me to get interested in the stock was a dividend yielding at least 5%. I’ve always wanted a big shareholder payment to compensate me for some of the risks of holding the shares. But for a long time, the valuation looked too high for my tastes and the yield too low.

However, the situation changed between mid-August and now when the share price plunged by around 25%. And the current level near 205p puts the company back on my watchlist. To put the move in perspective, the 25% decline is also how much lower the stock is over the past year. 

Lower earnings

My guess is the slide occurred because of lower earnings. The company issued its half-year results report in early October and the figures revealed how tough trading has been for the supermarket chain. Profits, earnings per share and cash inflow were all down year on year. But, crucially, the directors raised the interim dividend by just over 20%.

I reckon that move underlines the directors’ confidence in the outlook. And seeing some of them put their own money on the line with personal share purchases reassures me even more. 

However, positive long-term outcomes are never certain with stocks and shares. The signs look good to me with Tesco, but any business can suffer operational setbacks at any time. And I’m not forgetting the business got itself into trouble a few years back and had to turn itself around. I’m also mindful that the supermarket sector is competitive and the business is low-margin in nature and carrying a lot of debt.

Uncertainties ahead

In the interim report, chief executive Ken Murphy guided the market to expect full-year operating profit at the “lower end” of previous expectations. He said: “Significant uncertainties in the external environment still exist, most notably how consumer behaviour continues to evolve.”

I’m not expecting the Tesco share price to shoot the lights out in the years ahead. But I am hoping for the business to keep defending its position in the market against its many competitors. 

Times are tough. But even now the firm is turning a profit. And earnings cover the dividend payment around twice. My assumption is the company will keep on paying dividends and grow them a little each year. And, as such, I reckon the stock is a candidate for my diversified income-focused portfolio when I next get some spare cash.

More reading

Kevin Godbold has no position in any of the shares mentioned. 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.