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.
The pharmaceutical industry is going through a major transformation, as many companies are dealing with the expiration of patents on their most profitable drugs. Eli Lilly (NYSE: LLY ) trades at a low multiple to earnings precisely because of the uncertainty surrounding some of its biggest products. Will Lilly make it past the patent cliff unscathed and stronger than ever? Below, we'll revisit how Eli Lilly 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 Eli Lilly.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$45.1 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past 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||0.70||Pass|
|Worst loss in past five years no greater than 20%||(21.3%)||Fail|
|Valuation||Normalized P/E < 18||11.26||Pass|
|Dividends||Current yield > 2%||5.0%||Pass|
|5-year dividend growth > 10%||4.1%||Fail|
|Streak of dividend increases >= 10 years||0 years||Fail|
|Payout ratio < 75%||50.1%||Pass|
|Total score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Eli Lilly last year, the company has kept the same seven-point score. Like many of its peers, Lilly is dealing with the prospects of losing some high-sales drugs in the near future.
Just about every major pharmaceutical company has drugs going off-patent in the coming years. For Lilly, the casualties include Zyprexa, Cymbalta, Gemzar, and Humalog, which together represent a huge blow that the company needs to remedy.
Still, Lilly has had some successes. It will get a royalty from Amylin Pharmaceuticals (Nasdaq: AMLN ) for its diabetes drug, Bydureon. And further down its pipeline, Lilly's cholesterol drug evacetrapib delivered promising results in a phase 2 trial late last year. The problem there, though, is that Merck (NYSE: MRK ) and Amarin (Nasdaq: AMRN ) both have more advanced drugs in the cholesterol space. It's unclear at this early date whether evacetrapib will be able to distinguish itself from its rivals if they get approved first.
Another promising area is in treating Alzheimer's disease. Although Lilly's semagacestat failed in phase 3 trials, it has another drug, solanezumab, that could be more promising. Yet a rival drug from Pfizer and Elan (NYSE: ELN ) is also in line for accelerated approval, thanks to a recent initiative from the federal government.
For retirees and other conservative investors, Lilly's healthy dividend yield is very attractive. But you aren't getting paid that much without some risk. If you believe Lilly will address its patent cliff successfully, then the shares are cheaply priced with plenty of room to run.
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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