Is Rolls-Royce The Ultimate Retirement Share?

Published in Company Comment on 12 September 2012

Will shares in Rolls-Royce 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 Rolls-Royce Holdings (LSE: RR), one of the UK's oldest and best-respected engineering companies.

Engineering a profit

A look at the total return figures reveals that Rolls-Royce has outperformed the FTSE 100 over the last 10 years by an impressive margin:

Total Return20072008200920102011Trailing 10 yr avg.
FTSE 1007.4%-28.3%27.3%12.6%-2.2%7.0%

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.)

Rolls-Royce's trailing 10 year average total return of 20.5% is almost three times that of the FTSE 100 and highlights the strength of its global engineering business, the largest part of which is building jet engines for airliners.

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 Rolls-Royce shapes up:

Year founded1906
Market cap£15.5bn
Net debt£106m
Dividend Yield2.1%
5 year average financials
Operating margin5.7%
Interest cover12.7x
EPS growth10.6% (adj.)
Dividend growth13.4%
Dividend cover2.2x

Source: Morningstar, Digital Look, Rolls-Royce

Here's how I've scored Rolls-Royce on each of these criteria:

LongevityA genuine old-timer.5/5
Performance vs. FTSEIt's hammered the index over the last decade.5/5
Financial strengthVery solid; generous interest cover and currently has net cash.4/5
EPS growthPretty reasonable.3/5
Dividend growthSteady and consistent, above inflation.4/5
Total: 21/25

A score of 21/25 is excellent and suggests that Rolls-Royce could be a strong candidate for a retirement fund portfolio.

However, it's worth noting that Rolls-Royce does look a little expensive at the moment, with a P/E of 17 and a relatively low dividend yield of 2.1% -- compared to equivalent figures for the FTSE 100 of 15.7 and 3.4%.

Rolls' main civil aerospace engine business looks likely to remain profitable and robust and its three other divisions -- defence aerospace, energy and marine -- should provide enough diversity to offset downturns in individual markets. However, I would expect it to suffer in the event of a downturn in the oil and gas industry, as Rolls-Royce is quite heavily exposed to this sector through both its marine and energy divisions, which provide a variety of engines and power systems for oil platforms and ships.

Overall, I think Rolls-Royce has strong potential to be an excellent retirement share and it is on my own watch list, but I would prefer to buy it when it's a little cheaper -- at present, I would rather top up with cheap, high-yielding shares in BAE Systems (LSE: BA).

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 31 December 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 Mr 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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Further investment opportunities:

> Roland owns shares in BAE Systems but does not own shares in Rolls-Royce.

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The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

Retay 12 Sep 2012 , 4:30pm

Be careful with Rolls-Royce as they still support corruption by paying millions of Dollars to “odd” people who can force airlines to buy Rolls-Royce engines!
I tell the truth.

Dick Taylor (ex Rolls-Royce Technical Liaison Manager)

lameuse 13 Sep 2012 , 11:23am

As shareholders, I think we need to be a little hypocritical. Of course we wish to see our companies following the law of the land, but we also recognise that these "corrupt" payments are par for the course in a lot of overseas territories (maybe in UK too!). So ask yourself how strictly you wish to see YOUR company "corruption free" when everyone is at it!!

goodlifer 13 Sep 2012 , 10:43pm

"As shareholders, I think we need to be a little hypocritical."

Have you ever thought of going into politics?
Or the church?

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