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£3k to invest? I’d buy Tesco shares in an ISA to retire early

If you’ve got £3,000 to invest today, what should you buy? There are around 1,400 companies listed on the London market so you’ve plenty of choice. But in my view the best approach is also the easiest. If I was starting an investment today, I’d consider buying some Tesco (LSE: TSCO) shares.

I’d also make sure I put the shares into a Stocks and Shares ISA. The reason for this is simple – ISAs allow you to save up to £20,000 per year, completely tax-free. Over the years, investing in ISAs has saved me a lot of money.

Why Tesco?

Investing doesn’t need to be complicated. Indeed, I’d suggest that if you can’t understand a business (or its accounts), then that’s a warning flag not to invest.

I’m pretty sure that you’ll be familiar with the UK’s largest supermarket. Tesco’s market share is about 27%, which is one of its attractions. Market-leading companies enjoy economies of scale and strong brands. In my experience, this often makes them safer investments than smaller rivals.

Like its rivals, Tesco has had a busy year so far. Sales rose by 9.2% during the three months to 30 May, which is a very high growth rate for a big supermarket. However, chief executive Dave Lewis warned on Friday that handling the coronavirus pandemic has come at a significant cost. Profits won’t necessarily rise, despite the increase in sales.

I wouldn’t worry too much about this. Tesco shares rose ahead of the FTSE 100 on Friday as the market digested the firm’s strong performance. This included news that the firm has started taking market share from discounter Aldi for the first time in over 10 years.

Tesco shares are beating the market

Supermarkets have escaped the worst of the stock market crash, thanks to the defensive nature of their business. Whatever happens, people can’t stop buying food. Although the coronavirus pandemic is an extreme example of this, the same is true in a recession, when supermarkets usually perform quite well.

Tesco shares have outperformed the market by a good margin so far this year. The retailer’s share price is down by less than 10%, compared to a 19% drop for the blue chip FTSE 100 index.

This 4% income looks good to me

Even the best company can be a poor investment if you pay too much for the shares. Fortunately, I think Tesco shares look reasonably priced at the moment, especially when you consider the near-4% dividend yield that’s on offer. This compares very well with the 1% or so you’d get from a top cash ISA.

Although dividends are never guaranteed, I don’t see any reason for this payout to be cut. Tesco’s debt levels are falling and its cash generation looks good to me. Last year’s dividend was covered twice by earnings and free cash flow. I expect this safety margin to be maintained, reducing the risk of future problems.

At a share price of around 230p, Tesco is currently trading on around 15 times forecast earnings. Add in that dividend yield, and I think Tesco this is a great stock to buy today for a long-term portfolio.

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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.