Is BAT The Ultimate Retirement Share?

Published in Company Comment on 26 July 2012

Will shares in British American Tobacco help you build a FTSE-beating retirement fund?

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 UK 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 UK 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 British American Tobacco (LSE: BATS), the world's second-largest tobacco company and a favoured share amongst dividend investors (including Neil Woodford), thanks to its high profits and its policy of paying out 65% of earnings as dividends.

Smoking performance?

The addictive nature of their products makes tobacco companies good defensive shares; they perform well in a downturn. BAT has proved the truth of this by comprehensively outperforming the FTSE 100 over the last 10 years:

Total Return20072008200920102011Trailing 10 yr avg.
British American Tobacco41.6%-4.8%17.0%27.4%28.9%19.7%
FTSE 1007.4%-28.3%27.3%12.6%-2.2%7.1%

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.)

BAT has by far the best trailing 10-year average total return I have seen so far in this series, totally eclipsing the performance of the FTSE 100. This is the result of a combination of strong share price performance and solid dividend increases.

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 BAT shapes up:

ItemValue
Year founded1902
Market cap£64bn
Net debt£8.1bn
Dividend Yield3.9%
5 year average financials
Operating margin32.1%
Interest cover9.3x
EPS growth11.4%
Dividend growth19.7%
Dividend cover1.75x

Source: Morningstar, Digital Look, British American Tobacco

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

CriteriaCommentScore
LongevityMore than a century in the same business can't be bad.5/5
Performance vs. FTSEOutstanding performer, especially in bad times.5/5
Financial strengthGenerous interest cover and high returns but high gearing.3/5
EPS growthStrong brands and emerging markets have driven impressive growth.4/5
Dividend growthA well-defined and generous dividend policy has delivered excellent growth, although this has slowed slightly.4/5

Total: 21/25

A score of 21/25 highlights why British American Tobacco may be a strong candidate for a retirement fund portfolio -- something that leading fund manager Neil Woodford agrees with.

Woodford beats the market

City manager Neil Woodford manages more funds for private investors than any other fund manager, with a whopping £20bn of our money under his management. Over the last 15 years, Mr Woodford's stock picks have risen in value by a staggering 347%, during a period in which the wider market only gained 42%.

British American Tobacco is just one of Neil Woodford's eight biggest holdings. If you would like to know about all eight of his biggest holdings, then I strongly recommend you download this free Fool report "8 Shares Held By Britain's Super Investor" today. This free report covers all eight of Neil Woodford's biggest holdings and explains how and why he chose each one.

Don't delay -- "8 Shares Held By Britain's Super Investor" is completely free and available for a limited time only -- so I suggest you download it immediately.

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Further investment opportunities:

> Roland does not own shares in British American Tobacco.

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