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 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 Babcock International Group (LSE: BAB.L), which specialises in providing outsourced support services to the armed forces and other organizations.

Below the radar
Babcock only joined the FTSE 100 in June, when it was promoted from the FTSE 250. A look at the returns generated for Babcock shareholders over the last ten years shows why -- Babcock has clearly been a strong performer:

Total Return

2007

2008

2009

2010

2011

10-Year Trailing Average

Babcock International

42.7%

(13.6%)

28.9%

(1.2%)

32.3%

26.4%

FTSE 100

7.4%

(28.3%)

27.3%

12.6%

(2.2%)

7.3%

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.)

Babcock has massively outperformed the FTSE 100 over the last ten years and illustrates why the FTSE 250 is often a good place to look for lower-risk growth shares that pay reliable dividends.

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 Babcock International shapes up:

Item

Value

Year founded

1891

Market cap

3.5 billion pounds

Net debt

661 million pounds

Dividend yield

2.3%

5-Year Average Financials

Operating margin

6.5%

Interest cover

5.9x

EPS growth

22.8%

Dividend growth

24.9%

Dividend cover

2.6x

Source: Morningstar, Digital Look, Babcock International Group.

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

Criteria

Comment

Score

Longevity Long engineering pedigree but less experience as a service company.

4/5

Performance vs. FTSE Outstanding, albeit from a smaller start than its FTSE 100 peers.

4/5

Financial strength Fairly heavily geared but good cash generation and stable margins.

4/5

EPS growth Very respectable.

4/5

Dividend growth Impressive growth while keeping high levels of dividend cover. Yield not great.

4/5

Total: 20/25

Babcock International's links with the defense industry date back to the early 20th century and the company remained an engineering company until 2000, when it changed its focus to providing support services. Today, it is the Royal Navy's main outsourcing partner and also undertakes work for the other armed forces and civilian organizations. Babcock's switch to services seems to have been a good decision, because the last 10 years have seen substantial growth, culminating with the promotion of Babcock from the FTSE 250 to the FTSE 100, where it continues to perform well.

Beating the competition?
Indeed, Babcock has been so successful that it now trades at a slight premium to most of its peers in the support services sector. Babcock's price-earnings ratio of 15.7 and market value of 3.5 billion pounds make it larger and more expensive than its fellow defense specialist, Serco Group, which currently has a P/E of 14.6 and a market value of just 2.8 billion pounds. Babcock even profited from the failure of its peer G4S to deliver security staff for the Olympic games, providing transportation for the thousands of troops who were drafted in to replace non-existent G4S security staff.

Babcock's near-term prospects seem solid, with a healthy bid pipeline and rising profits. Major changes to defense policy could hamper its progress, but it seems unlikely that the U.K. government will ever reverse its strong commitment to outsourcing. Although Babcock's shares may be available more cheaply in the future, I think it represents reasonable value at present and with a score of 20/25, is a decent candidate for a retirement portfolio.

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.

The good news is that 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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Roland Head does not own shares of any companies mentioned in this article. The Motley Fool has a disclosure policy.
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