LONDON -- The last five years have been tough for those in retirement. Portfolio valuations have been hammered, and annuity rates have plunged. There's no sign of things improving anytime soon, either, as the eurozone and the U.K. economy look set to muddle through at best for some years to come.
A great way of protecting yourself from the downturn, however, is by building your retirement fund with shares of large, well-run companies that should grow their earnings steadily over the coming decades. Over time, such investments ought to result in rising dividends and inflation-beating capital growth.
In this series, I'm tracking down the U.K. large-caps that have the potential to beat the FTSE 100 (UKX) over the long term and support a lower-risk income-generating retirement fund (you can see all of the companies I've covered so far on this page).
Over the last few weeks, I've looked at 15 shares, and in this article, I'm going to examine the five top-scoring shares so far -- Pearson (PSON -0.06%), Associated British Foods (ABF 0.20%), Meggitt (MGGT), Petrofac (PFC) and Johnson Matthey (JMAT 2.00%).
First, let's take a look at how each of them scored against my five key retirement share criteria:
| Criteria | Pearson | Meggitt | Associated British Foods | Petrofac | Johnson Matthey |
|---|---|---|---|---|---|
| Longevity | 4/5 | 5/5 | 4/5 | 3/5 | 5/5 |
| Performance vs. FTSE | 4/5 | 4/5 | 4/5 | 4/5 | 4/5 |
| Financial strength | 4/5 | 4/5 | 4/5 | 5/5 | 4/5 |
| EPS growth | 3/5 | 3/5 | 4/5 | 5/5 | 4/5 |
| Dividend growth | 5/5 | 4/5 | 4/5 | 4/5 | 4/5 |
| Total | 20/25 | 20/25 | 20/25 | 21/25 | 21/25 |
Pearson
Pearson may be best known to investors as the owner of the Financial Times, but although the FT Group business is quite profitable, it only contributes around 12% of profits to Pearson's business -- 75% of profits come from its educational publishing business, with the remainder coming from the Penguin publishing business. There's regular speculation that Pearson might sell the FT Group, but from an investor's point of view, its educational business and the success of the new joint venture between Penguin and Random House are more important.
As a retirement share, Pearson has performed well in the past, increasing its dividend every year for at least a decade, meaning that investors who bought 10 years ago have seen their income almost double in that time.
Meggitt
I was quite impressed with engineer Meggitt's potential as a retirement share. It currently sits on a fairly modest price to earnings ratio (P/E) of 12.1 and offers a 2.7% dividend yield. While this level of income is below the FTSE 100 average of 3.3%, the likelihood of regular dividend increases looks high, and the company's payout ratio of around 30% of earnings per share should ensure that the dividend remains sustainable without restricting capital investment.
The majority of Meggitt's revenue comes from the civil aerospace and defense sectors, with around 10% coming from the energy industry. I quite liked this broad mixture of exposure, which should enable the company to ride out down-cycles in individual sectors without too much pain.
Associated British Foods
Associated British Foods makes its money from three distinct businesses: a portfolio of consumer food brands including Ovaltine and Twinings, its wholesale ingredients business, which is built around British Sugar, and from budget clothes retailer Primark, which it owns.
This diverse business proves that conglomerates can work, and ABF has had a good recession, making it extremely popular with investors. The firm has increased its dividend every year since at least 1993, and its share price has risen by 31% this year alone. As a result, ABF's shares now boast a P/E of 17 and yield just 1.9%, but they could be a great addition to a retirement portfolio should the price dip for any reason.
Petrofac
As I mentioned in my original review, Petrofac has proved the worth of making money by providing essential services to speculators, rather than speculating yourself. It's an oil services firm whose share price has risen by 613% over the last 10 years and that currently has $500 million in net cash and a $9.4 billion backlog of orders. Although there are some signs that order growth is flattening, this is unlikely to become material unless the price of oil falls dramatically -- yesterday, the company announced two new contracts worth $1.4 billion in Saudi Arabia.
From a retirement investing perspective, Petrofac provides an alternative way of gaining exposure to the oil sector. However, it currently trades on a much higher P/E than oil supermajors like BP and offers around half the dividend yield -- so it could be some years before Petrofac can offer the kind of income available from the big producers.
Johnson Matthey
Like ABF, Johnson Matthey offers a slightly below-average dividend yield but has an outstanding record of dividend increases -- something that is very important if you want your retirement income to keep pace with inflation. The firm is a chemicals business and one of the world's largest platinum refiners. After hitting record highs earlier this year, Johnson Matthey's share price has subsided somewhat, and the company now trades on a P/E of 15.3 and offers a yield of 2.3% -- both of which are slightly below average for the FTSE 100.
Finding good quality businesses with reliable dividend growth histories is a vital part of retirement investing, and Johnson Matthey looks like a good example to me. It could well be worth accepting its lower yield now, in order to gain access to its rising dividend yield on cost over the longer term.
Learn from the best
Doing your own research is important, but another good way of identifying great dividend-paying shares is to study the choices of successful professional investors. One of the most successful income investors currently working in the City is fund manager Neil Woodford, who had 21 billion pounds of private investors' funds under management at the end of October 2012 -- more than any other City manager.
Mr Woodford's track record is truly outstanding. His High Income fund grew by a staggering 342% in the 15 years to 31 October 2012, during which time the FTSE All-Share index only managed a gain of 125%.
You can learn about all eight of Neil Woodford's top holdings and see how he generates such fantastic profits in this free Motley Fool report. Many of Woodford's choices look like excellent retirement shares to me, and the report explains how he chose some of his biggest holdings.
This report is completely free and I strongly recommend you download "8 Shares Held By Britain's Super Investor" today, as it is available for a limited time only.
