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.
Conservative investors have always been drawn to utility stocks for their predictable, stable dividend payouts and solid business models. Among big utilities, Southern Co. (NYSE: SO ) stands out as a particularly good example of a company with these attractive traits. But with changes in the industry, will Southern be able to keep up? Below, we'll revisit how Southern Co. 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 Southern Co.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$41.4 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||3 years||Fail|
|Stock stability||Beta < 0.9||0.27||Pass|
|Worst loss in past five years no greater than 20%||(4.9%)||Pass|
|Valuation||Normalized P/E < 18||19.89||Fail|
|Dividends||Current yield > 2%||4.1%||Pass|
|5-year dividend growth > 10%||4%||Fail|
|Streak of dividend increases >= 10 years||11 years||Pass|
|Payout ratio < 75%||75.7%||Fail|
|Total score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Southern Co. last year, the company has lost a point. A tick down in revenue growth is to blame for the drop, but a nearly 20% gain for the stock in the past year is consolation enough for most investors.
Utilities have done well recently, with low natural gas prices pulling down coal along with it and making it cheaper overall to generate electricity. But some question whether the surge has come too far too fast. With its big stock-price gain, Southern's dividend yield is now near its lowest level on record, even though it has lower margins than American Electric Power (NYSE: AEP ) and several other rivals.
Even with the tailwind of low natural gas prices, Southern faces a big challenge. Converting coal use to natural gas could bring the dual benefit of lower costs and cleaner operation, but it also costs a ton of money. In addition, locked-in contracts for coal supply aren't always flexible in the short run, although Southern is doing its best to renegotiate contracts.
One interesting trend is the comeback of nuclear energy. After last year's Japanese earthquake and tsunami caused damage at a nuclear reactor, calls for an end to nuclear energy production were loud, and nuclear-focused utility Exelon (NYSE: EXC ) underperformed its rivals. But this past February, Southern got the go-ahead from the U.S. Nuclear Regulatory Commission to build two new nuclear reactors, the first approval in more than three decades. SCANA (NYSE: SCG ) also got permission to build reactors, raising the specter of heightened competition in the industry.
For retirees and other conservative investors, the recent completion of the Duke Energy (NYSE: DUK ) and Progress Energy merger presents Southern with a new competitive obstacle to overcome. Although the company is still the model of consistency, prudent investors may prefer to wait for a pullback before buying new shares.
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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