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 to protect 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 drinks giant Diageo
Strong stuff
Diageo reported its 2012 results today, highlighting another year of decent growth with total sales up 6% and emerging market sales up 15%. The company has performed very strongly against the FTSE 100 over the last 10 years, as these figures show:
|
Total Return |
2007 |
2008 |
2009 |
2010 |
2011 |
Trailing 10-Year Average |
|---|---|---|---|---|---|---|
| Diageo | 11.0% | (7.8%) | 16.6% | 12.8% | 22.1% | 10.3% |
| FTSE 100 | 7.4% | (28.3%) | 27.3% | 12.6% | (2.2%) | 6.4% |
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.
Diageo's index-beating trailing-10-year average total return suggests that it has the potential to outperform the FTSE 100 over the long term and make a strong contribution to a retirement 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 Diageo shapes up:
|
Item |
Value |
|---|---|
| Year founded | 1997* |
| Market cap | 42 billion pounds |
| Net debt | 6.6 billion pounds |
| Dividend yield | 2.6% |
| 5-Year Average Financials | |
| Operating margin | 27.7% |
| Interest cover | 6.0 times |
| EPS growth | 9.4% |
| Dividend growth | 5.9% |
| Dividend cover | 1.9 times |
Source: Morningstar, Digital Look, Diageo. *Diageo was created when Guinness PLC and Grand Metropolitan merged.
Here's how I've scored Diageo on each of these criteria:
|
Criteria |
Comment |
Score |
|---|---|---|
| Longevity | Young company, old brands and products. | 3/5 |
| Performance vs. FTSE | Strong and impressive. | 4/5 |
| Financial strength | High gearing offset by consistent high margins. | 3/5 |
| EPS growth | Decent in recent years but slowing (2% in 2012). | 3/5 |
| Dividend growth | Below average yield but decent growth and payout ratio. | 4/5 |
|
Total: 17/25 |
||
A score of 17/25 is respectable, and Diageo has the potential to deliver long-term capital and income growth and make a positive contribution to a retirement fund portfolio. At the same time, its P/E of 17.8 is relatively expensive and its 2.6% yield is well below the FTSE 100 average of 3.4% -- so anyone buying the share now needs a long-term view to reap the benefits of rising yield on cost.
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 has delivered an impressive 347% total return -- and thrashed the wider market -- during 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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