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 Berkshire Hathaway (NYSE: BRK-A ) (NYSE: BRK-B ) 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 Berkshire Hathaway.
|Factor||What We Want to See||Actual||Pass or Fail?|
|Size||Market cap > $10 billion||$165.1 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||4 years||Pass|
|Stock stability||Beta < 0.9||0.47||Pass|
|Worst loss in past five years no greater than 20%||(31.8%)||Fail|
|Valuation||Normalized P/E < 18||14.29||Pass|
|Dividends||Current yield > 2%||0%||Fail|
|5-year dividend growth > 10%||0%||Fail|
|Streak of dividend increases >= 10 years||NM||NM|
|Payout ratio < 75%||NM||NM|
|Total score||6 out of 8|
Source: Capital IQ, a division of Standard & Poor's. NM = not meaningful; Berkshire Hathaway has never paid a dividend. Total score = number of passes.
With six points, Berkshire Hathaway lacks one thing that conservative investors like to see in their stocks: a dividend. But with a host of strong businesses under the Berkshire umbrella, investors may nevertheless want to give Warren Buffett's famous company a second look.
Berkshire's core is its insurance operation. With car insurance giant Geico and Berkshire's own insurance and reinsurance operations, the company has made a business of taking smart risks and then investing premiums to obtain superior returns that then flow to the company's bottom line.
Thanks to having significant amounts of cash on hand, Berkshire has been able to use Buffett's reputation to take advantage of major market panics. In 2008, he provided capital to Goldman Sachs (NYSE: GS ) and General Electric (NYSE: GE ) in packages that combined impressive preferred stock dividends with equity kickers in the form of warrants. Goldman and GE have paid back the money to redeem their preferred stock, but the warrants still have years to run. The returns have been so impressive that Buffett did the same sort of deal with Bank of America (NYSE: BAC ) recently.
Many worry that Buffett's advanced age presents big risk when he inevitably steps down from his role. But in fact, that might open the door to the stock paying a dividend if Buffett's successor decides that reinvesting every penny of the company's float isn't the optimal strategy.
Retirees and other conservative investors who need income won't like Berkshire's lack of a payout. But even in troubled times and despite its concentration in the financial industry, Berkshire is still a good bet for a retirement portfolio.
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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