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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 Northrop Grumman (NYSE: NOC ) 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 Northrop Grumman.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$16.6 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||1.09||Fail|
|Worst loss in past five years no greater than 20%||(41.2%)||Fail|
|Valuation||Normalized P/E < 18||9.10||Pass|
|Dividends||Current yield > 2%||3.4%||Pass|
|5-year dividend growth > 10%||12.1%||Pass|
|Streak of dividend increases >= 10 years||8 years||Fail|
|Payout ratio < 75%||28.7%||Pass|
|Total score||6 out of 10|
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
Northrop Grumman posts a pretty strong score of 6. The defense giant is suffering the same uncertainties as its peers, but it's rewarding investors with a healthy and growing dividend with plenty of room for future increases.
Times have been tough for defense contractors overall. Government budget cuts forced General Electric (NYSE: GE ) to volunteer to continue building its alternate jet engine for the F-35 fighter on its own money. Moreover, the entire F-35 program is in jeopardy, putting Lockheed Martin (NYSE: LMT ) at risk.
As a result, defense companies are getting, well, defensive. Northrop, Boeing (NYSE: BA ) , and General Dynamics (NYSE: GD ) are just a few of the many companies that have announced workforce reductions in preparation for leaner times. The question, though, is just how bad the budget cuts will be. Foolish defense analyst Andrew Tonner thinks that concerns could be overblown, and with shares trading at bargain valuations, investors who dare to jump in now could get big rewards.
Still, investors want strong companies, and Northrop isn't delivering entirely positive news. Last week, Northrop Grumman released quarterly results that disappointed investors. Earnings from continuing operations dropped almost 30%, and the company's free cash flow actually went negative. But looking forward, the company increased its guidance for earnings and margins for the full year.
Retirees and other conservative investors have to like Northrop's healthy dividend, which exceeds a 3% yield and has been growing for eight consecutive years at a strong pace. But to invest in Northrop, you have to be willing to take on the risk of significant volatility depending on what the government does. If you can handle that risk, Northrop could be a good way to play a defense turnaround.
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.