Is National Grid 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 National Grid  (LSE: NG.L  ) (NYSE: NGG  ) , the company that operates most of the U.K.'s gas and electricity transmission networks and is also a perennial favorite with income investors, thanks to its high yield.

High voltage returns?
Here's how National Grid's investors have fared against the FTSE 100 over the last 10 years:

Total Return

2007

2008

2009

2010

2011

Trailing-10-year avg.

National Grid

17.2%

(13.9%)

4.6%

(13.0%)

19.8%

6.4%

FTSE 100

7.4%

(28.3%)

27.3%

12.6%

(2.2%)

7.7%

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.)

National Grid's performance against the FTSE 100 has been pretty respectable, and it is not far off matching the FTSE 100 on its trailing-10-year average total return.

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 National Grid shapes up:

Item

Value

Year founded

1990

Market cap

£24.9bn

Net debt

£22.7bn

Dividend Yield

5.8%

5-year-average financials

Operating margin

24.9%

Interest cover

3.1x

EPS growth

9% (adj.)

Dividend growth

9.7%

Dividend cover

1.7x

Source: Morningstar, Digital Look, National Grid

Here's how I've scored National Grid on each of these criteria:

Criteria

Comment

Score

Longevity A young company, but of course its assets are much older.

3/5

Performance vs. FTSE Underperforms on price but over performs on yield.

4/5

Financial strength By utility standards, it's solid high debt is the norm.

3/5

EPS growth Operating in the U.S. and U.K. helps diversify earnings growth.

4/5

Dividend growth Very good indeed -- well above inflation plus a high yield.

5/5

Total: 19/25

A score of 19/25 is pretty decent and highlights National Grid's appeal as a retirement portfolio share. Like most utilities, National Grid's business requires vast amounts of capital investment and the company is currently in the process of negotiating its pricing and investment obligations for the years 2013-2021 with its U.K. regulator, Ofgem. To provide an idea of the scale of these commitments, the initial proposals would require National Grid to spend around £15 billion on upgrading Britain's gas and electricity transmission networks.

The exact outcome of the proposals is yet to be confirmed and the pricing controls will dictate how much profit National Grid will be allowed to make over the next decade. An unexpected outcome could unsettle the company's share price for a short period, but it is worth remembering that it will only affect the U.K. side of the business -- close to half of National Grid's income now comes from its U.S. business. In the U.S., National Grid operates a number of regional gas and electricity networks, a business it has been expanding since 2000, when it acquired U.S. utility Niagara Mohawk.

Overall, I believe that National Grid is an excellent retirement share. Its business is stable and profitable and its long history of inflation beating dividend growth means that it should continue to provide a reliable income. While capital gains may be more limited, I don't think this is important for a retirement share, whose main purpose is to provide income, with as little trading as possible.

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 does not own shares in National Grid. Motley Fool newsletter services have recommended buying shares of National Grid. 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.
 


Read/Post Comments (3) | Recommend This Article (5)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 19, 2012, at 11:50 AM, 123spot wrote:

    Roland, nice article. I own NGG, but am considering owning more. When do you expect the rate negotiations will be completed? I hope you will publish a follow-up with your opinion of the implications of the decision.

    Also, analyzing the security of the dividend is a must for a retirement share rec. What is your opinion on that issue? Many thanks. Spot

  • Report this Comment On September 20, 2012, at 1:38 PM, 3chains wrote:

    Beware that NGG's dividend is a bit lumpy. NGG only pays its dividend twice a year. The first dividend is usually more than the second. The last two dividends add up to about $3, but one was closer to $2 and the other about $1.

  • Report this Comment On September 20, 2012, at 2:16 PM, 123spot wrote:

    chains, thanks. I didn't know that. Spot

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