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 UK 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 UK large-caps that have the potential to beat the FTSE 100 over the long term and support a lower-risk income-generating retirement fund (you can see the companies I've covered so far on this page).
Today, I'm going to take a look at accounting and business software specialists The Sage Group (SGE -0.81%).
Sage vs. FTSE 100
Let's start with a look at how Sage has performed against the FTSE 100 over the last 10 years:
| Total Returns | 2008 | 2009 | 2010 | 2011 | 2012 | 10 yr trailing avg |
|---|---|---|---|---|---|---|
| The Sage Group | -22.5% | 33.7% | 27.7% | 10.5% | 3.6% | 11.5% |
| FTSE 100 | -28.3% | 27.3% | 12.6% | -2.2% | 10% | 10% |
Source: Morningstar. (Total return includes both changes to the share price and reinvested dividends. These two ingredients combined are what make it possible for equity portfolios to regularly outperform cash and bonds over the long term.)
Sage's 10-year average trailing total return shows that it has managed to edge ahead of the FTSE 100 over the last ten years, but has it got the makings of a great retirement share?
What's the score?
To help me pinpoint suitable investments, I like to score companies on key financial metrics that highlight the characteristics I look for in a retirement share. Let's see how Sage shapes up:
| Item | Value |
|---|---|
| Year founded | 1981 |
| Market cap | £4.1bn |
| Net debt | £147.6m |
| Dividend Yield | 3% |
| 5-Year Average Financials | |
| Operating margin | 23.1% |
| Interest cover | 22.1x |
| EPS growth | 9.5% |
| Dividend growth | 7.7% |
| Dividend cover | 2.0x |
Here's how I've scored Sage on each of these criteria:
| Criteria | Comment | Score |
|---|---|---|
| Longevity | 32 years isn't all that long. | 3/5 |
| Performance vs. FTSE | A strong record. | 4/5 |
| Financial strength | Low gearing, strong cash generation, high margins. | 5/5 |
| EPS growth | Attractive, steady growth. | 4/5 |
| Dividend growth | Steady growth amply covered by free cash flow. | 5/5 |
| Total: 21/25 | ||
Sage's score of 21/25 highlights the company's attractions as a retirement share. It has a history of steady dividend increases and for the last six years at least, the firm's dividends have been covered by free cash flow two or more times, making them very safe and affordable. Sage's profit margins are high and while its relative youth might be a concern for a retirement portfolio, I think that the way Sage software has become an integral part of business computing -- rather like Microsoft Windows -- discounts this risk to some extent.
Sage has been in the FTSE 100 since 1999 and has gradually expanded the scope of its software beyond its initial accounting remit. Areas covered today include payroll, customer relationship management and a wide range of financial planning, forecasting and costing -- all of which is likely to become more critical and more automated in years to come.
My verdict
Although Sage's current dividend yield of 3% is slightly below the FTSE 100 average of 3.1%, I think that its well-covered, progressive dividends could make it very attractive for an income-based retirement portfolio.
Dividend growth is almost as important as outright yield when buying shares for a retirement portfolio, as it enables your income to keep pace with inflation. Income growth also means that in the years before you retire, the dividend yield on cost you receive from your shares will rise, often to levels far higher than the index average. If you had purchased Sage shares at the start of 2010, for example, your dividend yield on cost in 2012 would have been 4.3%, considerably higher than the FTSE 100 average.
Overall, I think that Sage provides an attractive way of gaining exposure to the IT and business services market, and could fit well into a diversified retirement portfolio.
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