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.
With all of today's economic challenges, shoppers want to get all the fashions they crave without having to pay an arm and a leg to buy them. That drive pushes shoppers toward Ross Stores (Nasdaq: ROST ) , which specializes in buying high-end merchandise from upscale retailers at big discounts and then passing the savings on to its customers. That strategy has worked well in recent years, but can its success continue? Below, we'll revisit how Ross Stores 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 Ross Stores.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$15.1 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||5 years||Pass|
|Free cash flow growth > 0% in at least four of past five years||4 years||Pass|
|Stock stability||Beta < 0.9||0.70||Pass|
|Worst loss in past five years no greater than 20%||(11.8%)||Pass|
|Valuation||Normalized P/E < 18||21.99||Fail|
|Dividends||Current yield > 2%||0.8%||Fail|
|5-year dividend growth > 10%||29.9%||Pass|
|Streak of dividend increases >= 10 years||18 years||Pass|
|Payout ratio < 75%||15.6%||Pass|
|Total score||8 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Ross Stores last year, the company has gained an extra point. Another year of free cash flow growth boosted the retailer's score, although a 70% gain in the shares over the past year has made the company much less attractive from a valuation standpoint.
There's no denying that Ross has found a valuable niche by catering to budget- and fashion-conscious customers. The company has even managed to outperform rival TJX (NYSE: TJX ) , whose TJ Maxx and other store concepts also focus on delivering name-brand merchandise at a discount.
You can see how much customers appreciate Ross by looking at the failures of more mainstream competitors. After last year's holiday season, Sears Holdings (Nasdaq: SHLD ) announced it would close as many as 120 stores, and the partial rebound in its stock since then seems more geared toward the company's real estate assets than any confidence in its retail operations. Moreover, JC Penney (NYSE: JCP ) has struggled in its attempted turnaround, with customers still not fully understanding its new everyday low pricing strategy. By contrast, Ross by definition offers all its merchandise at discounts to their original sale price. That's something that's easy to understand.
The only real concern for investors is whether shares have gone too high. Yet with high-end targeted lululemon athletica (Nasdaq: LULU ) fetching more than 40 times earnings even after a big hit to its stock, an earnings multiple of 22 for Ross isn't absurd, despite having no signs of being a bargain.
Retirees and conservative investors who've owned Ross for a while have already received a big part of their rewards from owning the stock. With a big advance in the stock and a dividend yield now below 1%, you should consider finding better alternatives with more potential growth for your retirement portfolio.
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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