Is Lloyds the Ultimate Retirement Share?

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 (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 Lloyds Banking Group (LSE: LLOY.L) (NYSE: LYG), one of two big British banks that was bailed out by the taxpayer in 2008.

Lloyds vs. FTSE 100
Let's start with a look at how Lloyds has performed against the FTSE 100 over the last 10 years:

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.)

A look at these figures makes you wonder how Lloyds survived at all -- and of course it wouldn't have, had it not been bailed out with 20 billion pounds of taxpayers money, a deal which resulted in the bank becoming 43% government-owned. So can Lloyds come back from the brink to become a solid, income-generating retirement share? Its share price is up by 74% so far this year, suggesting some investors think it can.

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 Lloyds shapes up:

Source: Morningstar, Digital Look, Lloyds Banking Group. *Lloyds paid a dividend in 2007 and 2008. The average level of cover for these two years was 0.9. It has not paid a dividend since 2008.

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

Lloyds made many of the same mistakes as Royal Bank of Scotland Group in the run-up to the financial crisis. For RBS, it was the misguided purchase of ABN Amro that was the final straw, while for Lloyds, it was the acquisition of Halifax Bank of Scotland (HBOS) that forced it to request a bailout, after wholesale funding markets dried up and it could no longer service HBOS' huge mortgage portfolio.

Since then, Lloyds has worked hard to sell-off non-core assets, writedown impaired assets and deal with the fallout from the PPI mis-selling scandal, for which it has so far set aside 5.3 billion pounds and already paid out a staggering 3.7 billion pounds. It now looks in much better shape, and city analysts are currently forecasting a full-year profit before tax of 2.4 billion pounds, followed next year by a return to dividend payments. To add to the appeal, Lloyds, like RBS, currently trades below its tangible book value -- its share price of 45 pence represents a 20% discount to its most recent net tangible asset value per share of 56.6 pence.

I believe that Lloyds will make a full recovery, but there are still too many uncertainties to make it a good retirement share buy at the moment. Like leading fund manager Neil Woodford, I believe the U.K.'s bailed-out banks have not yet fully unwound the consequences of their past mistakes and remain risky investments, especially given their lack of dividend income.

Top income picks
Neil Woodford is one of the most successful income investors currently working in the City. He manages more money for private investors than any other City manager, and his dividend stock picks outperformed the wider index by a staggering 305% in the 15 years to 31 December 2011.

Woodford always looks closely at companies' figures, and he saw the writing on the wall for the U.K.'s banks before the financial crisis struck, enabling him to sell his banking shares at a healthy profit and reinvest the proceeds in safer alternatives. The good news is that you can learn about Neil Woodford's current 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 click here to download it today, as it is available for a limited time only.