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 drilling industry has had a tumultuous couple of years. With the specter of the Gulf oil spill haunting the sector, Diamond Offshore (NYSE: DO ) faces the constant challenge of operating in deep water. Yet as a majority-owned subsidiary of Loews, Diamond Offshore has the confidence of a well-regarded parent company looking over its shoulder. Can the driller thrive with higher energy prices, despite the competition it faces? Below, we'll revisit how Diamond Offshore 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 Diamond Offshore.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$9.2 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||0.93||Fail|
|Worst loss in past five years no greater than 20%||(56.0%)||Fail|
|Valuation||Normalized P/E < 18||12.48||Pass|
|Dividends||Current yield > 2%||5.3%*||Pass|
|5-year dividend growth > 10%||(4.9%)*||Fail|
|Streak of dividend increases >= 10 years||0 years||Fail|
|Payout ratio < 75%||51.0%*||Pass|
|Total score||3 out of 10|
Source: S&P Capital IQ. Total score = number of passes. *Includes special dividends.
Since we looked at Diamond Offshore last year, the company's score has plunged by four points. Drops in growth and market cap, combined with a rise in share price volatility, have made it a less attractive choice for conservative investors.
Deepwater drilling has become a key component of success for offshore drillers. With easy finds in shallow water largely played out, Seadrill (NYSE: SDRL ) , Transocean (NYSE: RIG ) , and Noble (NYSE: NE ) have taken advantage of that trend by employing their respective fleets of ultra-deepwater rigs at lucrative rates. Similarly, Diamond Offshore has gotten good use out of its semisubmersible rigs, many of which operate at ultra-deepwater depths.
Diamond Offshore has made the most of the business environment to put together smart deals. It sold its Ocean Columbia rig to Hercules Offshore (Nasdaq: HERO ) for $85 million, which gave Diamond Offshore some useful cash but also provided Hercules with valuable cash flow. It also signed a long-term contract with Anadarko Petroleum to build two drillships for use in the Gulf of Mexico.
For retirees and conservative investors, however, the problem is that the stock is sensitive to changes in oil prices and drilling activity. Moreover, while its special dividends boost its yield, Diamond Offshore could easily cut them further -- as it has in the past. At least for now, there are more promising energy stocks than Diamond Offshore to put in your 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.
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