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.
For most people, there's nothing more important than getting their paycheck. Even if workers aren't always aware of it, many employers rely on Automatic Data Processing (Nasdaq: ADP ) to handle the nuts and bolts of their employee accounting, including cutting paychecks and making direct-deposit transfers with the right amounts withheld and sent to the proper places. The recession hurt ADP's business as unemployment rose, but lately workers seem to be getting jobs again. Will ADP see the benefit of a recovery? Below, we'll revisit how Automatic Data Processing 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 Automatic Data Processing.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$26.8 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%||(9.1%)||Pass|
|Valuation||Normalized P/E < 18||22.13||Fail|
|Dividends||Current yield > 2%||2.9%||Pass|
|5-year dividend growth > 10%||13.4%||Pass|
|Streak of dividend increases >= 10 years||37 years||Pass|
|Payout ratio < 75%||52.9%||Pass|
|Total score||9 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Automatic Data Processing last year, the company has indeed made a huge recovery, picking up two extra points. Solid revenue and free cash flow growth helped bring the company to the brink of a perfect score, although its valuation remains a bit too high to grab that elusive 10th point.
ADP shares the payroll and HR services industry with rival Paychex (Nasdaq: PAYX ) . ADP tends to focus on large corporations, while Paychex gravitates toward small businesses. So far, there's been room enough for both companies, as each has seen solid growth -- although ADP's growth has been faster.
But additional competition is starting to ramp up. Intuit (Nasdaq: INTU ) has traditionally provided tax and accounting software, but payroll is a natural expansion of its business. With its popular QuickBooks software, Intuit is more of a threat to Paychex than ADP at the moment, but Intuit certainly has the scale to appeal to larger employers in time. Also, Insperity (NYSE: NSP ) has had success focusing more on HR services, which carry higher margins in low-interest-rate environments like we've seen for several years.
For retirees and other conservative investors, ADP can't match Paychex on dividend yield, but its track record of significant boosts to its payout has no equal in the industry. With the only blemish on its record being a somewhat expensive share price, ADP deserves a close look for a spot 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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