Should You Buy and Hold American Capital?

Being able to retire rich, or at least comfortable, is the goal of almost any investor. However, it's much easier said than done. In a recent Wells Fargo survey, respondents between the ages of 50-59 said that they had, on average, about $29,000 saved up. With pensions all but gone, and Social Security targeted for cuts in the future, it's hard to count on anyone but yourself. But $29,000 isn't going to cut it for most people, so you've got to get involved in the stock market in order to grow that nest egg. Getting in the game is the easy part; choosing the right stocks is the hard part.

Making prudent decisions
Generally speaking, I look for four traits in a retirement stock:

  1. Valuation: Investors of all ages want to make sure they're not overpaying for a stock, but this matters even more in retirement. Retirees don't have the long time horizon that younger investors have, so it's essential to make sure you don't overpay in the short term.
  2. Dividends: Most retirees need a combination of both growth and income, as they'll be depending more and more on their portfolio to help with everyday expenses. Companies that pay dividends not only offer immediate income, but they've also proven to outperform non-paying dividend companies over long periods of time.
  3. Growth: Investors love dividends, but everyone wants to see their stocks rise over time. Growth can be as big a part of your portfolio as a steady dividend. It's important to note that you don't need a high-flying stock that's going to shoot to the moon; a company that can grow and outperform the market is hard enough to find, so steady growth is highly covetable.
  4. Low volatility: Retirees want to invest in great growth stocks just as much as anyone else, but they also want to be able to rest well knowing that their portfolio won't be taking them on a roller-coaster ride. At the end of the day, most retirees would rather own a sturdy company that lets them sleep at night than a company that whips up and down with the gyrations of the market.

Although some companies are definitely more geared toward retirees, which companies you choose to invest in will be dictated largely by what you already have in your portfolio. Small, mid, and large caps can all play a role in your investing strategy, so I chose to evaluate all varieties of stocks in this regular series.

So how does American Capital stack up?
In order to check out the valuation of American Capital (Nasdaq: ACAS  ) , we don't want to look at only its P/E ratio of 2.8. That may seem cheap, but really we don't know without looking at the ratio in historical context. Over the last five years, American Capital's average P/E ratio has been 5.56, which is greater than the current ratio. This suggests that investors could be seeing an opportunity to buy American Capital on the cheap right now. That being said, investors might be better served focusing on metrics other than earnings as the company’s profit or loss swings wildly with general market movements.

American Capital’s dividend is 0%. Although we love to see companies that pay dividends, unfortunately, American Capital does not. It did until 2008, but it obviously has not felt comfortable yet reinstituting that payout to shareholders. Continuing market turmoil could reduce the chance of future dividend payments, though it’s recently been suggested that the company use cash flow to buy back its shares while trading under NAV.

Next, we want to ensure that American Capital's stock has the ability to rise over the next five, 10, or 20 years. A company that's growing its net income has the best possible chance to see its share price rise over time. Of course, we can't predict the future, but we can look back to get an idea of how the company has performed in the past in order to try to ensure future earnings growth. Over the past five years, American Capital has grown its net income by 24.5% annually. Fortunately, American Capital has been able to grow its earnings over the past five years, and that's pretty significant considering all of the market turmoil in the last few years. Of course, this doesn't mean that growth will continue, but it's a great sign that the company can prosper in the face of difficulty.

One of the best measures of volatility is called beta. Beta measures the impact that the movement of the stock market will have on a particular stock. For instance, a beta of 1.0 signifies that American Capital will move in tandem with the market; a beta of 2.0 means that the stock will move up twice as much as the general market, and vice versa. In this particular case, American Capital has a beta of 2.48, which is pretty high. Generally speaking I like to see a beta below 1.2 for retirees.

Let's look at the competition
We've taken a look at American Capital, and maybe you think it's passed all the tests, or maybe you just don't feel comfortable with the results. Either way, it's beneficial to see how a company stacks up in its industry, because it's just as important to understand a company's competitors as it is to understand that particular company. Here are American Capital's stats when compared to three other potential buys across the larger financial industry:

Company

Current P/E

Dividend Yield

5-Year Net Income CAGR

1-Year Beta

American Capital 2.8 0% 24.5% 2.5
Fifth Street Finance   (NYSE: FSC  ) 17.4 9.9% N/A 0.8
Franklin Resources (NYSE: BEN  ) 17.4 0.7% 9.4% 1.5
The Blackstone Group (NYSE: BX  ) NM 2.3% N/A 1.9

Source: Capital IQ, a division of Standard & Poor's.

Each company has traits to like and traits left to be desired. Either way, it's beneficial to look at the industry picture and not just American Capital in isolation.

Of course, I can't decide for you whether or not this is the best stock for retirement, but it has passed two of the four tests, which shows that this stock has some promise. Depending on which traits are most important for you, you’d be wise to look further into this stock for your portfolio.

Interested in adding any of the companies above to your watchlist? Click below to get the latest commentary and analysis.

Jordan DiPietro owns no shares. The Fool owns shares of and has created a ratio put spread position on Wells Fargo. 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.


Read/Post Comments (3) | Recommend This Article (5)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 18, 2011, at 2:46 PM, micmaher wrote:

    Distribution yield on Blackstone is incorrect

  • Report this Comment On August 18, 2011, at 4:55 PM, MoneyOrBust wrote:

    This one scares the holy crap out of me...This stock is not for the faint of heart. If they are making money, then where is the dividend like FSC pays? FSC is a better choice here if you are looking for yield.

  • Report this Comment On August 18, 2011, at 11:14 PM, unfatcat wrote:

    ACAS was heavily leveraged and took a huge hit in the big crash. Before that they were always a good dividend payer. Malon Wilkus, the CEO, says he likes to pay dividends but they're holding until the debt is paid down. They're making money now and ACAS is the major holder of their child AGNC which is a REIT money machine for as long as the Fed keeps lending money for cheap. I think they'll be fine in the long run.

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