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.
ACE Limited (NYSE: ACE ) isn't the first name that comes to mind when you think about insurance companies. But the insurer sells a full range of products, including life insurance, property and casualty coverage, and reinsurance to peer insurance companies. With 2011 having been a tough year for insurers, though, no one in the industry has emerged unscathed. Can ACE recover? Below, we'll revisit how ACE 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 ACE.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$24.7 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||2 years||Fail|
|Stock stability||Beta < 0.9||0.75||Pass|
|Worst loss in past five years no greater than 20%||(13.0%)||Pass|
|Valuation||Normalized P/E < 18||19.00||Fail|
|Dividends||Current yield > 2%||2.7%||Pass|
|5-year dividend growth > 10%||8.9%||Fail|
|Streak of dividend increases >= 10 years||20 years||Pass|
|Payout ratio < 75%||29.0%||Pass|
|Total score||7 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at ACE last year, the company has dropped a point. Weaker earnings pulled the company's P/E ratio up sharply, calling its valuation into doubt.
2011 wasn't kind even to well-known insurance companies. Berkshire Hathaway (NYSE: BRK-A ) (NYSE: BRK-B ) suffered through a lackluster year, taking hits from providing catastrophe reinsurance and having to deal with disasters in both Japan and several parts of the U.S., culminating in Hurricane Irene's march up the Atlantic coast. Other insurers, including Allstate (NYSE: ALL ) and Travelers, saw similarly bad losses last year, with Allstate's second-quarter catastrophe losses topping the $2 billion mark.
But ACE hasn't let last year's woes stop it in its tracks. The company has remained solidly profitable throughout, unlike Montpelier Re (NYSE: MRH ) , which ended up suffering a big loss in 2011 in the wake of big policy payouts. Even better, ACE raised its dividend by more than a third in January, keeping up a two-decade streak of payout gains. Yet even with last year's relative earnings weakness, the company still pays out less than 30% of its earnings in dividends, leaving plenty of room for further boosts.
For retirees and other conservative investors, ACE's ability to stay solid even during times of trouble bodes well for its future. Often, strong insurance companies benefit from tough years, as they drive weaker competitors out of business. ACE should be well-placed to profit from a tighter reinsurance market going forward, and that makes it attractive, even at a somewhat inflated valuation.
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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