Are These the Ultimate Retirement Shares?

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 (INDEX: ^FTSE) 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 week or so, I've looked at Barclays (LSE: BARC.L), Diageo (LSE: DGE.L), WPP, BG Group (LSE: BG.L), and Serco (LSE: SRP.L). Let's take a look at how each of them scored against my five key retirement share criteria:

Income vs. growth
Despite their industry diversity, all of these companies have one thing in common -- they each offer dividend yields substantially below the FTSE 100 average. At the time of writing, the FTSE 100 offers a yield of 3.3%, but all of these shares yield less than 3%. Despite this, I think that some of them could make excellent retirement shares.

Outsourcing specialist Serco scored 21/25 in my review, despite yielding a miserly 1.5%. That's because investors from just five years ago will have enjoyed a 38% capital gain so far along with average dividend growth of almost 20% per year, delivering a five-year average trailing total return of 8% -- compared to 2.7% for the FTSE 100.

It's Serco's relentless growth that makes it an attractive retirement share -- and I don't think that it has finished growing yet. Serco is focused on emerging-market growth and on moving higher up the value chain in its outsourcing projects, but despite routinely outperforming the FTSE 100, it currently trades on a P/E of 14.5 -- below the FTSE 100 average of 15.7.

Diageo's portfolio of world-class drinks brands means that its products are heavily in demand in fast-growing emerging markets, where Western brands are a status symbol enjoyed by newly affluent middle-class consumers. Its premium brands mean that Diageo can price its products above competitors', providing it with generous profit margins and plenty of cash for expansion -- or dividend payouts.

Gas exploration and production company BG Group has delivered outstanding growth over the last two decades, but only very long-term holders enjoy a good yield from the shares, as the company's massive investment commitments mean its dividend payout ratio is quite low. Despite this, BG's dividend growth rate has historically matched its EPS growth rate, and over time it could become more generous, as the group's assets mature and require less intensive investment.

Advertising giant WPP has a long record of delivering growth through acquisitions and organic expansion, but has not managed to beat the FTSE 100 over the last 10 years. WPP's share price is very sensitive to economic conditions and it tends to underperform the market in bad times and outperform it in boom times, meaning that careful timing can pay dividends when buying WPP shares.

A recovery play
Barclays has delivered precious little growth in recent years, but unlike its part-nationalized peers, RBS and Lloyds, it has continued to pay a dividend to its long-suffering shareholders -- albeit greatly reduced. I think that Barclays is likely to make a strong recovery from its recent troubles and could well return to health faster than either RBS or Lloyds. In the long term, I have little doubt that it will retain its place in the premier league of U.K. banking and make a solid retirement share -- and if you agree, then there has rarely been a better time to buy Barclays shares.

An expert tip
Although doing your own research is important, one 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 manages 20 billion pounds of private investors' money -- more than any other City manager. Neil Woodford's dividend stock picks outperformed the wider index by a staggering 305% over the 15 years to Dec. 31, 2011.

You can learn about Neil Woodford's top holdings and 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.

Warren Buffett buys British! The legendary investor has recently topped up on his favorite U.K. blue chip. Discover what he bought -- and the price he paid -- within our latest free report!

Further investment opportunities:

• Here's How I Hope to Retire
• 10 Steps to Making a Million in the Market
• 8 Shares Held by Britain's Super Investor