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 tobacco industry is chock-full of companies that are household names, even among people who have never smoked in their lives. But behind the scenes, tiny Vector Group (NYSE: VGR ) has carved out a lucrative niche in the tobacco market. With minor brands including the USA and Pyramid labels, as well as private-label offerings, Vector remains under the radar but has stayed consistently profitable. Can Vector keep competing among giants? Below, we'll revisit how Vector Group 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 Vector Group.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$1.33 billion||Fail|
|Consistency||Revenue growth > 0% in at least four of five past years||5 years||Pass|
|Free cash flow growth > 0% in at least four of past five years||4 years||Pass|
|Stock stability||Beta < 0.9||0.42||Pass|
|Worst loss in past five years no greater than 20%||(21.6%)||Fail|
|Valuation||Normalized P/E < 18||43.68||Fail|
|Dividends||Current yield > 2%||9.5%||Pass|
|Five-year dividend growth > 10%||5.1%||Fail|
|Streak of dividend increases >= 10 years||0 years||Fail|
|Payout ratio < 75%||265.2%||Fail|
|Total score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With only four points, Vector Group doesn't give retirees and other conservative investors everything they like to see in a stock. While its growth has been solid, a recent drop in earnings has pushed valuations higher and escalated its payout ratio to extremely high levels.
Tobacco stocks may seem boring, but they've been consistent winners for years. Altria (NYSE: MO ) and Lorillard (NYSE: LO ) boast impressive net margins of more than 20%, largely due to their highly recognizable brand names and substantial advertising presence. Reynolds American (NYSE: RAI ) comes in with only slightly less impressive margins. Those favorable traits have pushed their shares up substantially in recent years.
By contrast, Vector's aim at the low-price discount market hasn't paid off so well. Because it's in the U.S. market, it lacks the growth potential that Philip Morris International (NYSE: PM ) has given investors by aiming exclusively at foreign markets. Yet even though very thin margins leave it scrambling to earn a profit, the stock has still done pretty well over the past four years, producing impressive returns even during the bear market year of 2008.
Where Vector shines is in its dividend yield, which approaches 10%. Yet even the company's free cash flow, which exceeds net income by a substantial margin, isn't nearly enough to support the payout, which has led the company to grow its debt steadily over the years.
For retirees and other conservative investors, the tug-of-war between high dividends and a lack of supporting cash flow makes Vector a riskier proposition than many other tobacco stocks. With trends favoring international tobacco stocks, retirement investors may do better to steer clear of Vector until its valuations are more in line with its fundamentals.
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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