Is Admiral the Ultimate Retirement Share?

LONDON -- The past five years have been tough for those in retirement. Portfolio valuations have been hammered and annuity rates have plunged. There's no sign that things will improve 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 Admiral Group (LSE: ADM.L  ) , the motor insurance company that operates Confused.com.

A short story
Let's take a look at how Admiral has performed against the FTSE 100 over the past five years -- 10-year figures aren't yet available, as Admiral only floated in 2004:

Total Returns

2007

2008

2009

2010

2011

5-Year Trailing Average

Admiral Group 4.1% (12.8%) 36.6% 34.0% (38.8%) 7.9%
FTSE 100 7.4% (28.3%) 27.3% 12.6% (2.2%) 1.3%

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.

Admiral's returns so far have been pretty impressive, but will it be able to sustain these over the long term as a part of a retirement fund portfolio?

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 Admiral shapes up:

Item

Value

Year founded 1993
Market cap 3 billion pounds
Net debt (cash) (224 million pounds)
Dividend yield 3.3%

5-Year Average Financials

Item

Value

Operating margin 55%
Interest cover N/A
EPS growth 15.6%
Dividend growth 18%
Dividend cover 2.4x

Sources: Morningstar, Digital Look, Admiral Group.

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

Criteria

Comment

Score

Longevity It's still a teenager. 2/5
Performance vs. FTSE Pretty good so far. 3/5
Financial strength Net cash and above-average profitability. 4/5
EPS growth Has delivered decent growth in recent years. 4/5
Dividend growth A strong record with a consistent payout policy. 4/5
    Total: 17/25

Admiral has impressed investors since its flotation, thanks to its generous dividend policy and above-average profitability. It pays out 45% of post-tax earnings and this year has declared a special dividend that has taken the forward dividend yield up to a desirable 7.5%. Yet its success may not be as sustainable as it first seemed. Three-quarters of Admiral's policies are reinsured, which means that Admiral buys insurance from other companies to cover claims on those policies. The advantage of this is that its costs are fixed and known in advance, but the disadvantage is that like any convenient, de-risking service, it comes at a price, which consumes a lot of Admiral's earnings.

There are signs that motor insurance premiums are beginning to fall and the recent ban on personal injury claim referral fees will also hit the company, as could the ongoing Competition Commission investigation into Britain's motor insurance industry. This investigation was triggered when an Office of Fair Trading investigation concluded that insurers were using inflated repair costs and hire car charges to milk consumers to the tune of 225 million pounds per year -- money that could potentially be subtracted from our premiums in years to come.

Overall, I think that Admiral's track record is a bit too short for me to choose it for a retirement portfolio. Despite its respectable score of 17/25, I'd prefer one of the two big general insurers, Aviva or RSA Insurance Group, both of which offer have much longer track records and currently offer yields in excess of 7.5%, without recourse to special dividends.

Top income picks
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. Woodford's dividend stock picks outperformed the wider index by a staggering 305% in the 15 years to Dec. 31, 2011.

The good news is that you can learn about 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:

Roland Head owns shares in Aviva but owns no shares in any of the other companies mentioned in this article.We Fools don't 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. The Motley Fool has a disclosure policy.


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