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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.
Reynolds American (NYSE: RAI ) is a major player in the U.S. tobacco industry, with brand names including Camel and Kool under its umbrella of cigarette and smokeless tobacco brands. As with all tobacco companies, though, Reynolds faces constant challenges from regulators and threats of litigation. Dividend-hungry investors have downplayed those challenges, but should you dismiss them so easily? Below, we'll revisit how Reynolds American 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 Reynolds American.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$26.4 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||2 years||Fail|
|Free cash flow growth > 0% in at least four of past five years||3 years||Fail|
|Stock stability||Beta < 0.9||0.56||Pass|
|Worst loss in past five years no greater than 20%||(34.7%)||Fail|
|Valuation||Normalized P/E < 18||17.94||Pass|
|Dividends||Current yield > 2%||5.1%||Pass|
|5-year dividend growth > 10%||8.7%||Fail|
|Streak of dividend increases >= 10 years||8 years||Fail|
|Payout ratio < 75%||96.5%||Fail|
|Total score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Reynolds American last year, the company has lost a point. The stock is up 20% in the past year, but a higher payout ratio from falling earnings has made Reynolds' current valuation look far less attractive than it did in 2011.
For years, Reynolds and other tobacco stocks have been a cash cow for dividend investors. Alongside Altria (NYSE: MO ) and Lorillard (NYSE: LO ) on the U.S. side and Philip Morris International (NYSE: PM ) focusing on international markets, Reynolds and its peers have largely been able to avoid big-ticket lawsuit awards and controlled their potential liability quite well in the past decade.
But Reynolds doesn't have clear sailing ahead. Falling revenue led it to cut its workforce by as much as 10% over the next two years. Altria also announced job cuts, and even discounter Vector Group (NYSE: VGR ) has seen the impact of declines in sales volume.
Regulatory efforts are partially to blame. Although Reynolds, Lorillard, and Vector managed to fight off an FDA requirement to put huge graphic warning labels on cigarette packs, the industry now faces a big ad campaign from the Centers for Disease Control and Prevention.
For retirees and other conservative investors, Reynolds continues to have an attractive yield above 5%. But current earnings multiples are extremely high compared to the company's historical P/E ratio levels. Buying shares of Reynolds for your retirement portfolio right now would force you to pay a high mark-up, and that's not typically something that risk-averse investors prefer to do.
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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