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.
Retirees and dividend-paying utilities go together like a horse and carriage. But not all utilities are the same. Electric provider National Grid (NYSE: NGG ) gives investors an interesting and unusual combination: exposure to both U.S. and international markets. But is that a winning combination? Below, we'll look at how the company 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 National Grid.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$33.6 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||2 years||Fail|
|Stock stability||Beta < 0.9||0.27||Pass|
|Worst loss in past five years no greater than 20%||(36.8%)||Fail|
|Valuation||Normalized P/E < 18||11.33||Pass|
|Dividends||Current yield > 2%||6%||Pass|
|5-year dividend growth > 10%||6.9%||Fail|
|Streak of dividend increases >= 10 years||2 years||Fail|
|Payout ratio < 75%||42.3%||Pass|
|Total score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
National Grid only scores five points, which isn't enough to give conservative investors everything they'd want from a stock. The dividend is valuable and looks solid, but inconsistent growth and the inherent uneven nature of international-stock dividends makes the payouts less predictable than with pure U.S. companies.
National Grid is a U.K.-based company that has a very strong competitive position across the Atlantic. In the U.S., the company operates in the Northeast and New England. But with electrical infrastructure in the U.K. in poor shape, National Grid did a secondary offering of shares back in 2010 that earned investors' ire for being dilutive.
Yet National Grid gets a huge portion of its income from the U.K., where service rates automatically adjust for inflation, so the move should pay off in the long run. Moreover, with expertise in rebuilding infrastructure, National Grid will have a competitive advantage when it comes time to make upgrades to its U.S. lines.
The big question, though, is how National Grid will respond to increasing consolidation in the industry. With huge mergers on the table, including Duke Energy's (NYSE: DUK ) prospective buyout of Progress Energy (NYSE: PGN ) and Exelon (NYSE: EXC ) matching up with Constellation Energy (NYSE: CEG ) , National Grid could find itself without a much-needed partner if it wants to expand beyond the northeastern corner of the U.S.
Retirees and other conservative investors like the 6% yield, though, which exceeds those of peers Southern (NYSE: SO ) and American Electric Power (NYSE: AEP ) . If the economy continues to strengthen, then increased demand for electricity should keep those dividend checks coming -- and growing -- for the foreseeable future.
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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