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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.
Banks have been anything but safe for investors in recent years. But one place where banks have done a better job staying conservative and safe is Canada. One such bank, Royal Bank of Canada (NYSE: RY ) , has done reasonably well at keeping financially healthy, maintaining its dividend throughout the financial crisis. But now that the U.S. banking system has recovered substantially, can RBC maintain its competitive advantage not just against its southern rivals but also its Canadian counterparts? Below, we'll revisit how Royal Bank of Canada 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 Royal Bank of Canada.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$73.1 billion||Pass|
|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||2 years||Fail|
|Stock stability||Beta < 0.9||0.64||Pass|
|Worst loss in past five years no greater than 20%||(40.2%)||Fail|
|Valuation||Normalized P/E < 18||14.23||Pass|
|Dividends||Current yield > 2%||4.4%||Pass|
|5-year dividend growth > 10%||6.9%||Fail|
|Streak of dividend increases >= 10 years||2 years||Fail|
|Payout ratio < 75%||64.2%||Pass|
|Total score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Royal Bank of Canada last year, the company has lost a point. A slowdown in dividend growth is the cause, but the combination of a falling stock price and a recent payout boost have given the bank a much higher yield than it had this time last year.
Investors have looked to RBC and its Canadian peers for protection from the huge losses that U.S. banks suffered. Because the Canadian banking system in general and its mortgage practices in particular discourage long-term loans in favor of alternatives that borrowers repay more quickly, Canadian banks don't have as much repayment or interest rate risk in their portfolios.
But some believe that RBC may have missed out on a growth opportunity. Competitors Toronto-Dominion (NYSE: TD ) and Bank of Montreal (NYSE: BMO ) have aggressively moved into the U.S. market, while RBC decided last year to sell its U.S. retail business to PNC Financial (NYSE: PNC ) for $3.6 billion. The bank's CEO said that RBC was simply too small an operation in the U.S. to achieve the scale needed to become a major player south of the border.
Still, RBC hasn't given up on growth. It was one of the bidders for the international wealth management unit of Bank of America (NYSE: BAC ) recently, which includes operations in Europe, Latin America, Asia, and the Middle East. If RBC wins the bid, it could represent a huge growth opportunity for the bank.
For retirees and other conservative investors, RBC's second consecutive annual dividend increase earlier this year came as a welcome return to the consistent dividend growth investors came to expect before the financial crisis. Despite a mid-range score, RBC is worth a look as a possible investment in a solid financial company in a safer environment.
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.
If you really want to retire rich, no one stock will get the job done. Instead, you need to know how to prepare for your golden years. The Motley Fool's latest special report will give you all the details you need to get a smart investing plan going, plus it reveals three smart stocks for a rich retirement. But don't waste another minute -- click here and read it today.
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