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.
Payroll processing may seem like a bulletproof business, as companies always have employees to take care of. But during the recession, major job losses led to businesses cutting back on workers, which was especially bad news for Paychex (Nasdaq: PAYX ) because of its reliance on smaller employers. With the economy bouncing back, however, can Paychex finally start rebounding more strongly? Below, we'll revisit how Paychex 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 Paychex.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$10.9 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||0.85||Pass|
|Worst loss in past five years no greater than 20%||(24.6%)||Fail|
|Valuation||Normalized P/E < 18||20.64||Fail|
|Dividends||Current yield > 2%||4.3%||Pass|
|5-year dividend growth > 10%||11.2%||Pass|
|Streak of dividend increases >= 10 years||1 year||Fail|
|Payout ratio < 75%||84.0%||Fail|
|Total score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Paychex last year, the company has kept its five-point score. Shares have fallen slightly, but that's only made the stock's dividend yield look more attractive.
Traditionally, Paychex has split the payroll processing sector with Automatic Data Processing (Nasdaq: ADP ) , with ADP taking larger clients and Paychex sticking with smaller businesses. That serves Paychex well during expansions in which smaller businesses drive overall economic growth, but it can come back to bite Paychex during tough times.
That's one reason Paychex has tried to diversify its offerings lately, going beyond mere payroll to provide a wider suite of HR services. With the move, Paychex faces other competitors, such as quick-growing Insperity (NYSE: NSP ) and broad-line consultant giant Accenture (NYSE: ACN ) , but Paychex still believes it will provide faster growth than its payroll segment over the long haul.
The big wild card that Paychex and its peers face is Intuit (Nasdaq: INTU ) . With the company already providing accounting and tax software, Intuit is a natural fit to take over payroll services as well. That could prove to be a big problem for Paychex if it can't figure out a way to defend its turf against Intuit's promise of integrated services at lower cost.
For retirees and other conservative investors, the fact that Paychex has withstood a tough recessionary environment is an unquestionable sign of the resilience that the stock has. Although a lower valuation would be nice to get, retirement investors who are satisfied with a 4% yield that isn't likely to grow significantly until earnings recover may simply prefer to buy shares now.
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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