Is National Grid The Ultimate Retirement Share?

Published in Company Comment on 18 September 2012

Will shares in National Grid 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 National Grid (LSE: NG) (NYSE: NGG.US), the company that operates most of the UK's gas and electricity transmission networks and is also a perennial favourite with income investors, thanks to its high yield.

High voltage returns?

Here's how National Grid's investors have fared against the FTSE 100 over the last 10 years:

Total Return20072008200920102011Trailing 10 yr avg.
National Grid17.2%-13.9%4.6%-13.0%19.8%6.4%
FTSE 1007.4%-28.3%27.3%12.6%-2.2%7.7%

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.)

National Grid's performance against the FTSE 100 has been pretty respectable, and it is not far off matching the FTSE 100 on its trailing 10-year average total return.

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 National Grid shapes up:

ItemValue
Year founded1990
Market cap£24.9bn
Net debt£22.7bn
Dividend Yield5.8%
5 year average financials
Operating margin24.9%
Interest cover3.1x
EPS growth9% (adj.)
Dividend growth9.7%
Dividend cover1.7x

Source: Morningstar, Digital Look, National Grid

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

CriteriaCommentScore
LongevityA young company, but of course its assets are much older.3/5
Performance vs. FTSEUnderperforms on price but over performs on yield4/5
Financial strengthBy utility standards, it's solid - high debt is the norm3/5
EPS growthOperating in US and UK helps diversify earnings growth.4/5
Dividend growthVery good indeed -- well above inflation plus a high yield.5/5
Total: 19/25

A score of 19/25 is pretty decent and highlights National Grid's appeal as a retirement portfolio share. Like most utilities, National Grid's business requires vast amounts of capital investment and the company is currently in the process of negotiating its pricing and investment obligations for the 2013-2021 with its UK regulator, Ofgem. To provide an ideal of the scale of these commitments, the initial proposals would require National Grid to spend around £15bn on upgrading Britain's gas and electricity transmission networks.

The exact outcome of the proposals is yet to be confirmed and the pricing controls will dictate how much profit National Grid will be allowed to make over the next decade. An unexpected outcome could unsettle the company's share price for a short period, but it is worth remembering that it will only affect the UK side of the business -- close to half of National Grid's income now comes from its US business. In the US, National Grid operates a number of regional gas and electricity networks, a business it has been expanding since 2000, when it acquired US utility Niagara Mohawk.

Overall, I believe that National Grid is an excellent retirement share. Its business is stable and profitable and its long history of inflation-beating dividend growth means that it should continue to provide a reliable income. While capital gains may be more limited, I don't think this is important for a retirement share, whose main purpose is to provide income, with as little trading as possible.

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 does not own shares in National Grid.

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