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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 McGraw-Hill (NYSE: MHP ) 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 McGraw-Hill.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$13.4 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of past five years||3 years||Fail|
|Free cash flow growth > 0% in at least four of past five years||4 years||Pass|
|Stock stability||Beta < 0.9||1.19||Fail|
|Worst loss in past five years no greater than 20%||(45.6%)||Fail|
|Valuation||Normalized P/E < 18||16.09||Pass|
|Dividends||Current yield > 2%||2.3%||Pass|
|5-year dividend growth > 10%||7.1%||Fail|
|Streak of dividend increases >= 10 years||38 years||Pass|
|Payout ratio < 75%||34.9%||Pass|
|Total score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of six, McGraw-Hill has many of the things that conservative investors like to see in a stock. The company has a diversified set of businesses under its umbrella, but many of them have seen tough times lately.
McGraw-Hill is arguably best known for its educational publishing. The company publishes textbooks and creates computerized instruction tools for young students, competing with fellow publishers Pearson (NYSE: PSO ) and privately held Houghton Mifflin and Reed Elsevier. That business has seen relatively slow sales growth, but operating profit for the segment jumped almost 32% in 2010.
What you may not know is that McGraw-Hill also has a major presence in the financial industry, thanks largely to its Standard and Poor's division. Like Moody's (NYSE: MCO ) , S&P rates bonds and other securities, and through its media and information segment, the company provides data and information that competes against Thomson Reuters (NYSE: TRI ) .
It's S&P that has gotten McGraw-Hill the most attention lately. S&P took a lot of criticism after failing to anticipate the mortgage meltdown that led to 2008's financial crisis. Yet now, perhaps in an attempt to overcompensate, S&P recently downgraded the debt outlook for the U.S. government from stable to negative, showing a hint of just how powerful the ratings provider is in the financial world.
For investors, though, the real question is whether McGraw-Hill can overcome the challenges traditional publishers and media sources are facing now. So far, the company has done a reasonable job, seeing consistent free cash flow growth even through the recession and increasing its dividend regularly. If the company can stay the course, retirees and other conservative investors could find McGraw-Hill to be a compelling story.
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.