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.
If you like big trucks, you've gotta love Caterpillar (NYSE: CAT ) . With bulldozers, excavators, backhoes, and just about any other piece of heavy machinery you can think of, Caterpillar has become a vital component of world economic growth, with equipment that lets a variety of businesses do business better. But with economic slowdowns around the world, can the good times keep rolling? Below, we'll revisit how Caterpillar 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 Caterpillar.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$54.4 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||3 years||Fail|
|Free cash flow growth > 0% in at least four of past five years||2 years||Fail|
|Stock stability||Beta < 0.9||1.84||Fail|
|Worst loss in past five years no greater than 20%||(36.8%)||Fail|
|Valuation||Normalized P/E < 18||12.28||Pass|
|Dividends||Current yield > 2%||2.5%||Pass|
|5-year dividend growth > 10%||8.6%||Fail|
|Streak of dividend increases >= 10 years||19 years||Pass|
|Payout ratio < 75%||20%||Pass|
|Total score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Caterpillar last year, the company has dropped a point. Slowing dividend growth cost the equipment maker the point, but more important is the stock's nearly 20% decline in the past year.
Caterpillar has greatly benefited from world growth in recent years. Long a leader in construction equipment, Caterpillar's purchase of Bucyrus, which it completed last year, gave it additional exposure to the mining and resources industries.
China and Australia have been particularly strong growth areas for Caterpillar. Although competitors Joy Global (NYSE: JOY ) and General Electric (NYSE: GE ) have tried to capitalize on growth opportunities in the region, Caterpillar recently purchased Chinese equipment maker ERA Mining Machinery to boost its presence there.
Recently, though, concerns about a slowdown have hit the industry. Like Terex (NYSE: TEX ) and Manitowoc (NYSE: MTW ) , Caterpillar has seen its share price drop substantially as everyone watches to see if China will be able to manage a soft landing, or if growth falls even more sharply. In the long run, though, the correction will likely prove to be a buying opportunity.
In its most recent earnings report, Caterpillar crushed estimates, as earnings per shares jumped 67% and revenue rose 21% from the year-ago quarter. Boosting its guidance for the remainder of 2012, Caterpillar saw the best results from North America, even as Europe sagged. Moreover, revenue was almost evenly split between construction and resource buyers.
For retirees and other conservative investors, Caterpillar offers a reasonable combination of growth prospects, dividend income, and good value. Despite high volatility, investors with some risk tolerance should look at it as a potential addition to their retirement portfolios.
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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