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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.
Europe has been an economic battlefield for quite a while now, and Spain is near the epicenter of the current round of concerns. With Spanish bond yields soaring, investors are shying away from Spanish telecom giant Telefonica (NYSE: TEF ) , fearing a European slowdown that could hurt its future earnings. But with significant exposure to Latin America, Telefonica's prospects go well beyond the Continent. Are investors being short-sighted about the company? Below, we'll revisit how Telefonica 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 Telefonica.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$57 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||1 year||Fail|
|Stock stability||Beta < 0.9||0.62||Pass|
|Worst loss in past five years no greater than 20%||(28.6%)||Fail|
|Valuation||Normalized P/E < 18||10.90||Pass|
|Dividends||Current yield > 2%||16.7%*||Pass|
|5-year dividend growth > 10%||21.7%*||Pass|
|Streak of dividend increases >= 10 years||0 years||Fail|
|Payout ratio < 75%||167.2%||Fail|
|Total score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes. *Based on trailing dividend.
Since we looked at Telefonica last year, the company has lost a point. Despite its high trailing dividend yield, its payout ratio has risen high enough that the company now expects dividend cuts in both 2012 and 2013.
Investors have painted Telefonica with the same brush that they've used for most other telecom stocks in Europe, avoiding the stock. Along with France Telecom (NYSE: FTE ) and Telecom Italia (NYSE: TI ) , Telefonica has seen its shares track the fading economic health of their respective home countries, as dividends look to fall and economists begin to project a long potential recession for Europe.
But what those investors ignore is the fact that Telefonica has more exposure to Latin America than to Spain. Although not quite half of its sales come from Latin America, its operations there are more profitable, and thus it makes up more than 60% of the company's operating income.
Of course, Latin America has had its troubles as well. But with Brazil hosting the World Cup in 2014 and the Olympics in 2016, the country will have every incentive to bulk up its telecom system to put on a good face for visitors. And although Telefonica faces plenty of competition from Vodafone (Nasdaq: VOD ) , Portugal Telecom (NYSE: PT ) , and other players, the market is large enough to give everyone a chance to profit.
Retirees and other conservative investors have to be careful that Telefonica's price already reflects an imminent dividend cut, so don't let the current yield fool you. Nevertheless, if you think that investors are throwing away the baby with the bathwater here given the company's Latin American presence, then Telefonica may be a high-risk, high-potential-reward way to bet on Europe turning out better than many fear.
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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