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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. In this series, I look at 10 measures to show what makes a great retirement-oriented stock.
With fears of a double-dip recession, investors are interested in stocks that will protect and preserve their capital. Family Dollar (NYSE: FDO ) did a good job of doing that in the last slowdown, but does it have what it takes this time around? Below, we'll take a look at how Family Dollar does on our 10-point scale.
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 Family Dollar.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$6.45 billion||Fail|
|Consistency||Revenue growth > 0% in at least four of past five years||5 years||Pass|
|Free cash flow growth > 0% in at least four of past five years||4 years||Pass|
|Stock stability||Beta < 0.9||0.22||Pass|
|Worst loss in past five years no greater than 20%||(33.3%)||Fail|
|Valuation||Normalized P/E < 18||17.32||Pass|
|Dividends||Current yield > 2%||1.3%||Fail|
|5-year dividend growth > 10%||11.1%||Pass|
|Streak of dividend increases >= 10 years||35 years||Pass|
|Payout ratio < 75%||21.5%||Pass|
|Total score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With seven points, Family Dollar gives conservative investors most of the attractive traits they like in a stock. Although the company is small, it has proven its ability to stand up in tough times, and dividend growth is part of its appeal despite a current yield that leaves something to be desired.
During the recession, companies like Family Dollar, Wal-Mart (NYSE: WMT ) , and McDonald's (NYSE: MCD ) offered a deep-value proposition that resonated with cash-strapped consumers. In particular, Family Dollar's stock rose by more than 20% in 2008, as customers discovered the even-bigger bargains that Family Dollar and peers Dollar Tree (Nasdaq: DLTR ) and 99 Cents Only (NYSE: NDN ) had.
You'd expect that after the recession ended, Family Dollar might suffer. But with fears that we're entering yet another bear market, investors are gravitating toward defensive stocks again. And despite a huge drop in free cash flow, the stock has advanced strongly this year -- although some of those gains likely came from takeover speculation that has now ended.
For retirees and other conservative investors considering the stock, the problem is that discounts can only go so far before they start eating into profits. High freight and fuel costs have forced the company to cut margins. But with a 35-year history of steadily raising dividends and a valuation that still isn't particularly expensive, Family Dollar is worth a look for your 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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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.