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 Severn Trent , one of the U.K.'s largest water companies. Utilities -- with their reliable dividends -- are a traditional favorite of retirement investors, so how does Severn Trent shape up?
Severn Trent vs. FTSE 100
Let's start with a look at how Severn Trent has performed against the FTSE 100 over the last 10 years:
10 yr trailing avg
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.
Severn Trent's 10-year average trailing total return shows that its performance has been very close to that of the FTSE 100. However, total return is made up of both share price return and dividend payments, whereas many utility investors, like me, are only interested in the income potential of these regulated businesses.
Severn Trent's share price has only gone up by 58% over the last 10 years, compared to 77% for the FTSE 100. Given that Severn Trent and the FTSE 100 have posted very similar total returns, this weaker share price performance suggests that Severn Trent's historical dividend yield is considerably higher than that of the FTSE 100 -- good news for income-hungry investors.
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 Severn Trent shapes up:
5 year average financials
Here's how I've scored Severn Trent on each of these criteria:
It's relatively young by FTSE 100 standards.
Performance vs. FTSE
It's almost level with the index, but offers a higher yield.
Heavily geared, even by utility standards, but profitable.
After falling for several years, earnings seem to be on the rise again.
A cut in 2011 spoiled the firm's high growth rate.
Severn Trent's score of 16/25 is not outstanding, but is influenced by the water utility's high debt and lackluster earnings performance over the last few years. The company's debt does not appeal to me -- for the last four years at least, interest payments have exceeded dividend payments, while gearing has risen from 53% in 2003 to 80% at the end of the 2012 financial year. Although profits and earnings per share are likely to have grown strongly this year, I would like to see some sign that this 10-year progression of rising debt is coming to a halt.
Even if Severn Trent appeals to you as a retirement or income share, now may not be the best time to buy shares in a water utility. The current regulated price agreement for water utilities comes to an end in 2014, and negotiations for its replacement are under way. Utility shares have a historical tendency to underperform as uncertainty builds toward the end of a regulatory period, and Severn Trent's current dividend policy of delivering RPI plus 3% annual increases only runs until the end of 2014, when a new policy will be announced based on budgetary restrictions for the next five-year regulatory period.
I think there's a good chance that Severn Trent's shares might get cheaper later this year, but for anyone looking to invest at the moment, I strongly believe that there are more attractive income opportunities in the regulated utility sector -- one of which I mention below.
2013's top income stock?
The utility sector is known for its reliable, above-average dividends, but the Motley Fool's team of analysts has identified one FTSE 100 utility share that they believe offers a particularly high-quality income opportunity.
The company in question offers a 5.7% dividend yield and the Fool's analysts believe that it could be worth up to 850 pence per share -- offering new investors a potential 20% gain on the current share price of around 700 pence.
Indeed, the Motley Fool's analysts are so confident in this share that they've named their report "The Motley Fool's Top Income Stock For 2013!" This exclusive new report is completely free, but will only be available for a limited time -- so click here to download your copy now.
The article Is Severn Trent the Ultimate Retirement Share? originally appeared on Fool.com.
Roland Head has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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