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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.
What We Want to See
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.
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.
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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