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Is Reynolds American the Right Stock to Retire With?

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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 Reynolds American (NYSE: RAI  ) 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 Reynolds American.

Factor

What We Want to See

Actual

Pass or Fail?

Size Market cap > $10 billion $20.6 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 3 years Fail
Stock stability Beta < 0.9 0.66 Pass
  Worst loss in past five years no greater than 20% (34.7%) Fail
Valuation Normalized P/E < 18 14.21 Pass
Dividends Current yield > 2% 5.9% Pass
  5-year dividend growth > 10% 11.3% Pass
  Streak of dividend increases >= 10 years 7 years Fail
  Payout ratio < 75% 77.5% Fail
       
  Total score   5 out of 10

Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.

Reynolds American rolls up five points, giving conservative investors some of what they'd like to see in a stock. The company's dividends are relatively strong, but weak revenue and free cash flow growth in recent years could spell long-term trouble for the stock.

Investors in tobacco stocks know what they're getting into. Altria (NYSE: MO  ) , Lorillard (NYSE: LO  ) , and Reynolds have all faced the looming specter of tobacco litigation liability for decades. That makes the shares somewhat volatile, but at the same time, long-term investors have largely benefited from their outsized dividends and stable to upward-tracking share prices.

But public opinion of smoking in the U.S. has never been worse. As fellow Fool Morgan Housel recently discovered, a majority of U.S. citizens want to make all public smoking illegal. That puts U.S.-centered tobacco companies like Reynolds at a distinct disadvantage to global powerhouse Philip Morris International (NYSE: PM  ) , which largely sells in areas of the world with much less strict regulations -- although that could change soon as well. The moves have spurred interest in nontraditional tobacco sellers like Star Scientific (Nasdaq: CIGX  ) , although that company is just getting started.

What may make Reynolds worth a closer look is its low level of leverage. At 62%, the company's debt-to-equity ratio is well below Altria's and British American Tobacco's (AMEX: BTI  ) .

Balance sheet strength certainly doesn't make Reynolds an ideal pick for retirees and other conservative investors. But for strong dividend income, those who are willing to gamble on the prospects for tobacco regulation should give Reynolds a closer look.

Keep searching
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.

Add Reynolds American to My Watchlist, which will aggregate our Foolish analysis on it and all your other stocks.

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.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. You can follow him on Twitter here. The Motley Fool owns shares of Altria and Philip Morris International. Motley Fool newsletter services have recommended buying shares of Philip Morris International and writing puts on Lorillard. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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Related Tickers

4/23/2014 4:02 PM
RAI $53.40 Down -1.61 -2.93%
Reynolds American,… CAPS Rating: ****
BTI $114.47 Down -0.88 -0.76%
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CIGX $0.00 Down +0.00 +0.00%
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