Is Rolls-Royce the Ultimate Retirement Share?

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 the companies I've covered so far on this page).

Today, I'm going to take a look at Rolls-Royce Holdings  (LSE: RR.L  ) , one of the U.K.'s oldest and best-respected engineering companies.

Engineering a profit
A look at the total return figures reveals that Rolls-Royce has outperformed the FTSE 100 over the last 10 years by an impressive margin:

Total Return

2007

2008

2009

2010

2011

Trailing-10-year avg.

Rolls-Royce

22.0%

(38.5%)

44.2%

30.2%

21.4%

20.5%

FTSE 100

7.4%

(28.3%)

27.3%

12.6%

(2.2%)

7%

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.

Rolls-Royce's trailing-10-year average total return of 20.5% is almost three times that of the FTSE 100 and highlights the strength of its global engineering business, the largest part of which is building jet engines for airliners.

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 Rolls-Royce shapes up:

Item

Value

Year founded

1906

Market cap

£15.5bn

Net debt

£106m

Dividend Yield

2.1%

5-year-average financials

Operating margin

5.7%

Interest cover

12.7x

EPS growth

10.6% (adj.)

Dividend growth

13.4%

Dividend cover

2.2x

Source: Morningstar, Digital Look, Rolls-Royce

Here's how I've scored Rolls-Royce on each of these criteria:

Criteria

Comment

Score

Longevity A genuine old-timer.

5/5

Performance vs. FTSE It's hammered the index over the last decade.

5/5

Financial strength Very solid; generous interest cover and currently has net cash.

4/5

EPS growth Pretty reasonable.

3/5

Dividend growth Steady and consistent, above inflation.

4/5

Total: 21/25

A score of 21/25 is excellent and suggests that Rolls-Royce could be a strong candidate for a retirement fund portfolio.

However, it's worth noting that Rolls-Royce does look a little expensive at the moment, with a P/E of 17 and a relatively low dividend yield of 2.1% -- compared to equivalent figures for the FTSE 100 of 15.7 and 3.4%.

Rolls' main civil aerospace engine business looks likely to remain profitable and robust, and its three other divisions -- defense aerospace, energy, and marine -- should provide enough diversity to offset downturns in individual markets. However, I would expect it to suffer in the event of a downturn in the oil and gas industry, as Rolls-Royce is quite heavily exposed to this sector through both its marine and energy divisions, which provide a variety of engines and power systems for oil platforms and ships.

Overall, I think Rolls-Royce has strong potential to be an excellent retirement share and it is on my own watch list, but I would prefer to buy it when it's a little cheaper -- at present, I would rather top up with cheap, high-yielding shares in BAE Systems  (LSE: BA.L  ) .

Expert selections
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 manages more money for private investors than any other City manager. Neil Woodford's dividend stock picks outperformed the wider index by a staggering 305% in 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.

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Further investment opportunities:

Roland Head owns shares in BAE Systems but does not own shares in Rolls-Royce.The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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