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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 FirstEnergy (NYSE: FE ) 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 FirstEnergy.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$18.8 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||3 years||Fail|
|Stock stability||Beta < 0.9||0.53||Pass|
|Worst loss in past five years no greater than 20%||(30.6%)||Fail|
|Valuation||Normalized P/E < 18||17.58||Pass|
|Dividends||Current yield > 2%||4.8%||Pass|
|5-year dividend growth > 10%||4.3%||Fail|
|Streak of dividend increases >= 10 years||0 years||Fail|
|Payout ratio < 75%||126.9%||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, FirstEnergy isn't giving conservative investors everything they like to see. The utility stock has the dividend yield that the industry is famous for, but lackluster growth and a high payout ratio make the stock's distributions seem somewhat risky.
FirstEnergy is an electric utility company primarily serving the mid-Atlantic region. Investors have long valued utilities as a conservative, boring way to earn reliable income from their portfolios.
As it turns out, though, FirstEnergy's business is getting cutthroat. The company is making inroads into the Midwest, with lower rates in Ohio giving it a competitive advantage against better-established utilities American Electric Power (NYSE: AEP ) and Duke Energy (NYSE: DUK ) . In addition, FirstEnergy has gone as far west as Illinois to challenge Exelon (NYSE: EXC ) for customers in the town of Fulton on the Mississippi River.
Unfortunately, FirstEnergy has seen its costs increase because of rising fuel prices and plant maintenance expenses. As with PPL (NYSE: PPL ) and Dominion Resources (NYSE: D ) , those costs dealt a blow to FirstEnergy's profitability.
For retirees and conservative investors, FirstEnergy's dividend is probably the most attractive attribute. But unlike most of its competitors named above, FirstEnergy pays out more than its current earnings in dividends. In the long run, that could spell trouble for the dividend, so risk-averse investors may want to look elsewhere in the utility space to fill out their retirement portfolios.
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."