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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.
Unlike most of the upstart technology companies over the past 40 years or so, IBM (NYSE: IBM ) has an illustrious history of innovation since before the dawn of the computer. Yet perhaps the most impressive thing about IBM is how it completely remade itself from a hardware giant to an IT-services company at just about exactly the right time, avoiding a fate that other computer makers fell into. Can IBM keep moving forward? We'll revisit how IBM 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 IBM.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$224 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||0.67||Pass|
|Worst loss in past five years no greater than 20%||(20.8%)||Fail|
|Valuation||Normalized P/E < 18||17.88||Pass|
|Dividends||Current yield > 2%||1.6%||Fail|
|5-year dividend growth > 10%||21.4%||Pass|
|Streak of dividend increases >= 10 years||16 years||Pass|
|Payout ratio < 75%||22.1%||Pass|
|Total score||8 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at IBM last year, the company's score has improved by a point. Another year of free cash flow growth has helped boost the tech giant, but what retirees and other conservative investors should appreciate most is the company's detailed five-year plan toward future success.
Ordinarily, you get only a piece of a company's strategic vision. But under now-former CEO Sam Palmisano, IBM made extensive financial plans and goals for its future. With Ginni Rometty now at the helm, knowing what IBM's direction would be undoubtedly helped smooth the transition and give investors confidence in the new leader.
IBM's legacy hardware business still plays a key role in its success. In its most recent quarter, the company expanded its market-share lead over Oracle's (Nasdaq: ORCL ) Sun unit as well as Hewlett-Packard (NYSE: HPQ ) in the Unix systems market. But IT service order backlogs hit a whopping $141 billion, giving IBM a solid base of business to count on.
Interestingly, IBM has been so successful that others are seeking to emulate it. Oracle and HP have long tried to adapt IBM strategies to their own business. More recently, Cisco (Nasdaq: CSCO ) is following the same recipe, trying to bundle all of its network products and services into a single package to give customers everything they want from a single supplier. That poses a long-term threat for IBM, but Big Blue has experience handling such threats.
For retirees and conservative investors, IBM's dividend is only modest at this point, even though the company sports a very low payout ratio. A boost in the payout would give investors just about everything they'd want from a stock for their 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.
If you really want to retire rich, no one stock will get the job done. Instead, you need to know how to prepare for your golden years. The Motley Fool's latest special report will give you all the details you need to get a smart investing plan going, plus it reveals three smart stocks for a rich retirement. But don't waste another minute -- read it today.
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