Now more than ever, a comfortable retirement depends on secure, stable investments. Unfortunately, the right stocks for retirement won't just fall into your lap. In this series, I look at 10 measures to show what makes a great retirement-oriented stock.
The housing bust has destroyed entire swaths of the U.S. economy. From homebuilding stocks to mortgage lenders, once-thriving industries are still struggling to survive and recover. Yet while it would have been reasonable to expect home improvement retailer Home Depot (NYSE: HD ) to be in the path of destruction from the housing crash, the company has actually found ways to hold its own and even grow in the tough environment. But can remodels and an emphasis on less adventuresome projects provide enough growth to keep the stock on its upward trajectory? Below, we'll revisit how Home Depot does on our 10-point scale.
The right stocks for retirees
With decades to go before you need to tap your investments, you can take greater risks, weighing the chance of big losses against the potential for mind-blowing returns. But as retirement approaches, you no longer have the luxury of waiting out a downturn.
Sure, you still want good returns, but you also need to manage your risk and protect yourself against bear markets, which can maul your finances at the worst possible time. The right stocks combine both of these elements in a single investment.
When scrutinizing a stock, retirees should look for:
- Size. Most retirees would rather not take a flyer on unproven businesses. Bigger companies may lack their smaller counterparts' growth potential, but they do offer greater security.
- Consistency. While many investors look for fast-growing companies, conservative investors want to see steady, consistent gains in revenue, free cash flow, and other key metrics. Slow growth won't make headlines, but it will help prevent the kind of ugly surprises that suddenly torpedo a stock's share price.
- Stock stability. Conservative retirement investors prefer investments that move less dramatically than typical stocks, and they particularly want to avoid big losses. These investments will give up some gains during bull markets, but they won't fall as far or as fast during bear markets. Beta measures volatility, but we also want a track record of solid performance as well.
- Valuation. No one can afford to pay too much for a stock, even if its prospects are good. Using normalized earnings multiples helps smooth out one-time effects, giving you a longer-term context.
- Dividends. Most of all, retirees look for stocks that can provide income through dividends. Retirees want healthy payouts now and consistent dividend growth over time -- as long as it doesn't jeopardize the company's financial health.
With those factors in mind, let's take a closer look at Home Depot.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$74.6 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||2 years||Fail|
|Free cash flow growth > 0% in at least four of past five years||3 years||Fail|
|Stock stability||Beta < 0.9||0.79||Pass|
|Worst loss in past five years no greater than 20%||(31.1%)||Fail|
|Valuation||Normalized P/E < 18||19.05||Fail|
|Dividends||Current yield > 2%||2.4%||Pass|
|5-year dividend growth > 10%||6.3%||Fail|
|Streak of dividend increases >= 10 years||3 years||Fail|
|Payout ratio < 75%||40.7%||Pass|
|Total score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Home Depot last year, the company has dropped two points. Slowing dividend growth and a big increase in its earnings multiple hurt Home Depot's score, although few investors will complain about a 40% jump in its shares in a largely flat market overall.
For years, Home Depot has demonstrated how share prices don't necessarily match up with business conditions. Even though the stock has rebounded sharply from its financial-crisis lows, Home Depot's business has suffered for years, as a weak environment hurt the company and archrival Lowe's (NYSE: LOW ) made major gains in the space.
But 2011 was a strong rebuilding year for Home Depot. Some signs of life in the housing market helped reawaken interest in the space, with niche providers Lumber Liquidators (NYSE: LL ) and Trex (NYSE: TREX ) bouncing off depressed levels as demand for flooring and decking materials started to come back. Hurricane Irene and other weather events also drove some business gains at Home Depot and its peers.
More recently, though, concerns in the industry are on the rise once more. Late last month, Lowe's gave cautious guidance immediately after Home Depot reported sales that missed analyst estimates. The past month has also brought huge declines for homebuilders, as PulteGroup (NYSE: PHM ) is off by almost a quarter since early May, and its peers are also struggling. As long as the health of the housing market remains in question, Home Depot will have big challenges to overcome.
For retirees and other conservative investors, Home Depot has enjoyed a huge bull run in anticipation of an improving industry. If that improvement ends up getting delayed, now could prove to be a disastrous time to buy the stock. Risk-averse investors should look at the more cheaply priced Lowe's or wait for a better opportunity to buy the stock at a lower price.
Finding exactly the right stock to retire with is a tough task, but it's not impossible. Searching for the best candidates will help improve your investing skills, and teach you how to separate the right stocks from the risky ones.
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