I’m a huge fan of the UK’s ISA system, which allows us to save or invest up to £20,000 tax-free each year. That means no capital gains tax on future profits, and no income tax on interest or dividend payments.
My investing strategy is to add stocks to my ISA that can provide long-term income growth. Right now, I’m looking for shares that will be reliable performers even if the economy does start to slow.
In this article I’ll explain why I’d buy Tesco (LSE: TSCO) shares today for my ISA. I also plan to look at a smaller stock which I think could be a similar long-term defensive winner.
1. A proven winner
Tesco is by far the biggest supermarket in the UK, with a market share of 27%, versus about 15% each for second-place Sainsbury’s and Asda.
Tesco is also the most profitable of the UK’s listed supermarkets. I think this is at least partly due to the economies of scale that result from its size.
Supermarkets are generally seen as a defensive investment. Even during recessions, people’s shopping habits tend to remain relatively unchanged. I think it’s worth having at least a few defensive stocks in your portfolio, to help smooth out the more volatile performance of cyclical businesses.
During his five years in charge, chief executive Dave Lewis has cut debt and returned the business to growth. Mr Lewis is leaving next year, but I expect his replacement, Ken Murphy to deliver continued progress and a rising dividend.
2. The price is right
The Tesco share price has risen by 23% so far in 2019. The shares may no longer be an outright bargain, but I don’t think they’re overpriced.
Earnings growth is expected to run at between 5% and 10% over the next couple of years, while dividend growth is expected to be higher. Against this outlook, I think the stock’s valuation on 14 times 2019/20 earnings looks reasonable.
Although Tesco’s dividend yield of 3.4% is below the FTSE 100 average of 4.5%, I expect the payout to continue rising. In my view, the shares make good sense as a defensive long-term income buy.
What about growth?
I don’t think Tesco is likely to get all that much bigger than it is already. But I have identified one sector that seems to have defensive characteristics and strong growth potential.
Self-storage has proved increasingly popular in towns and cities as more people rent or live in shared accommodation. Growth in this sector has been strong for a number of years, but results from upcoming firm Lok’n Store Group (LSE: LOK) suggest to me that there’s plenty of gas left in the tank.
In numbers released today, Lok’n Store said that its sales rose by 10.3% to £17m last year, while underlying operating profit rose by 11.1% to £5.1m. Importantly, the group improved both its occupancy levels (+6%) and unit pricing (+0.6%).
Five new stores were opened during the year to 31 July and the firm has a pipeline of 14 stores. As these stores are opened, they will increase the group’s current estate by more than 40%, to 48 stores.
The UK self-storage market is highly fragmented. Professional operators like Lok’n Store are aiming to modernise and consolidate the industry. Although LOK shares trade at a premium to book value and yield just 2.1%, I believe they remain a decent buy for growth.
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Roland Head 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.
Motley Fool UK 2019