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.
Merck (NYSE: MRK ) is one of the largest, best-known pharmaceutical companies in the world. With a place in the prestigious Dow Jones Industrials, Merck is the company behind blockbuster drugs Singulair and Fosamax. Yet like many of its peers, Merck is already dealing with patent expirations. Can Merck get past the patent cliff unscathed? Below, we'll revisit how Merck 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 Merck.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$114 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||3 years||Fail|
|Stock stability||Beta < 0.9||0.66||Pass|
|Worst loss in past five years no greater than 20%||(45.3%)||Fail|
|Valuation||Normalized P/E < 18||18.29||Fail|
|Dividends||Current yield > 2%||4.5%||Pass|
|5-year dividend growth > 10%||2.0%||Fail|
|Streak of dividend increases >= 10 years||1 year||Fail|
|Payout ratio < 75%||74.8%||Pass|
|Total score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Merck last year, the company has kept its five-point score. But a recent dividend boost restored some faith in the company for income-hungry retirement investors.
Merck has had a strong line of successful drugs in the past, including asthma and allergy treatment Singulair, diabetes drug Januvia, and Zetia to treat cardiovascular problems. But the company will lose patent protection on Singulair later this year, raising questions about how to keep revenue and profits up.
Merck is trying to respond by coming up with replacement drugs, but the going isn't always easy. The company said last month that insomnia drug suvorexant had posted promising results in phase 3 trials, but even some approved drugs in the space haven't performed well on the sales front.
In addition, an ever-changing competitive landscape threatens even patent-protected drugs. For instance, with diabetes, Bristol-Myers Squibb (NYSE: BMY ) and AstraZeneca (NYSE: AZN ) have been trying without success to get the FDA to approve its dapagliflozin drug, which would help the two companies compete against Merck's Januvia more effectively. Yet Amylin Pharmaceuticals (Nasdaq: AMLN ) got FDA approval for Bydureon earlier this year, and although the drug is injected rather than taken orally like Januvia, Bydureon can expect strong sales, benefiting not just Amylin but also royalty-holder Eli Lilly (NYSE: LLY ) .
For retirees and other conservative investors, the big question is whether Merck can stand its ground as the competition for potential blockbusters for big pharma pipelines becomes fiercer. With its shares somewhat pricey compared to its peers and a relatively high payout ratio, Merck may be a case in which retirement investors would prefer to wait for a pullback.
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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