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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 the world's population growing above 7 billion recently, few things are more important than making food. Fertilizer companies like Terra Nitrogen (NYSE: TNH ) make population growth possible, with compounds designed to increase food production and crop yields. But with the company already having seen huge growth, can the trend toward higher food prices last long enough to justify new investors putting their money into the stock? Below, we'll look at how Terra Nitrogen 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 Terra Nitrogen.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$3.55 billion||Fail|
|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||3 years||Fail|
|Stock stability||Beta < 0.9||0.72||Pass|
|Worst loss in past five years no greater than 20%||(28.7%)||Fail|
|Valuation||Normalized P/E < 18||12.78||Pass|
|Dividends||Current yield > 2%||8.3%||Pass|
|5-year dividend growth > 10%||44.3%||Pass|
|Streak of dividend increases >= 10 years||1 year||Fail|
|Payout ratio < 75%||80.6%||Fail|
|Total score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With only four points, Terra Nitrogen isn't growing confidence among conservative investors, who seek more from the stocks they prefer. You can't argue with the fertilizer maker's dividend, but big swings in sales and cash flow show just how volatile the ag sector can be.
2011 was a great year for Terra Nitrogen. With high food prices, farmers could afford to pay for fertilizer. Moreover, Terra Nitrogen in particular benefited from its nitrogen-based fertilizers, which cost a lot less to produce than mineral-intensive fertilizers such as potash. The challenges of potash production were a big reason why PotashCorp (NYSE: POT ) and Mosaic (NYSE: MOS ) vastly underperformed Terra Nitrogen last year, as their gross margins can't compete with the lower cost structure of nitrogen.
Looking forward, plans for farmers to increase plantings bode well for Terra Nitrogen this year. But competitor CVR Partners (NYSE: UAN ) , which produces urea ammonium nitrate, is also seeking to boost its fertilizer production capacity, which could eventually put pressure on Terra Nitrogen's pricing.
Retirees and other conservative investors should keep in mind that Terra Nitrogen's big dividend yield comes from its status as a master limited partnership, with majority control resting in CF Industries (NYSE: CF ) . Still, with a vastly superior yield to both CF and most of its traditional fertilizer rivals, Terra Nitrogen is an income investor's dream -- and one that could keep delivering the goods as long as the bull market in agriculture lasts, if you're willing to deal with the ups and downs along the way.
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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