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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. Let's figure out what makes a great retirement-oriented stock, then examine whether Merck (NYSE: MRK ) has what we're looking for.
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 Merck.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$98.2 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||4 years||Pass|
|Free cash flow growth > 0% in at least four of past five years||2 years||Fail|
|Stock stability||Beta < 0.9||0.69||Pass|
|Worst loss in past five years no greater than 20%||(45.3%)||Fail|
|Valuation||Normalized P/E < 18||17.70||Pass|
|Dividends||Current yield > 2%||4.7%||Pass|
|5-year dividend growth > 10%||0%||Fail|
|Streak of dividend increases >= 10 years||0 years||Fail|
|Payout ratio < 75%||549.8%||Fail|
|Total score||5 out of 10|
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With just five points, Merck doesn't deliver everything that retirees and other conservative investors would like to see in stocks they own. Despite its healthy current dividend yield, the stock hasn't been very stable recently, and the company faces some big challenges ahead.
Merck made a big move when it merged with Schering-Plough in an attempt to bolster its pipeline. Unlike Pfizer (NYSE: PFE ) , which slashed its dividend in half when it took over Wyeth, Merck managed to sustain its dividend after its big merger. But the company hasn't raised its payout in nearly seven years, and although its payout ratio is artificially high at the moment, there's little indication that the company plans to resume dividend growth anytime soon.
Merck isn't relying solely on acquisition hopes to boost its future prospects. Like competitor Eli Lilly (NYSE: LLY ) , Merck spends a great deal on research and development for new drugs. Last year, Merck spent almost 18% of its total revenue on R&D, lagging behind Lilly's 21% but well ahead of Pfizer and GlaxoSmithKline (NYSE: GSK ) , which both clock in right under 14%.
Unfortunately for investors, Merck has had big swings in recent years. Unlike several of its peers, Merck had a huge drop in 2008. With a big rebound in free cash flow over the past year, it's entirely possible that the company has turned the corner. But if you're a risk-averse investor, you'll probably want to wait to see more proof before relying on Merck as part of 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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If you want to retire rich, you need to be confident that you've got the basics of your investment strategy down pat. See if you're on track by following the 13 Steps to Investing Foolishly.