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.
Investors often ignore basic materials as being inherently more boring than finished products. But for the companies that need them, those materials are far from boring. Cliffs Natural Resources (NYSE: CLF ) is a great example, as it represents one of the major producers of iron ore and metallurgical coal for use in steel production. With the global economy in slowdown mode, Cliffs faces some big challenges. Does the company have the strength to stand up to hard times? Below, we'll revisit how Cliffs Natural Resources 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 Cliffs Natural Resources.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$5.1 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||2.38||Fail|
|Worst loss in past five years no greater than 20%||(48.8%)||Fail|
|Valuation||Normalized P/E < 18||4.95||Pass|
|Dividends||Current yield > 2%||7.0%||Pass|
|5-year dividend growth > 10%||42.4%||Pass|
|Streak of dividend increases >= 10 years||3 years||Fail|
|Payout ratio < 75%||14.8%||Pass|
|Total score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Cliffs Natural Resources last year, the company has kept its six-point score. But the stock has plunged more than 50% as the bottom has fallen out of the commodities sector due to sluggish levels of economic activity, especially in China.
As the producer of key ingredients for steel production, Cliffs relies on the health of the steel industry. Unfortunately, times have been tough for steelmakers, as U.S. Steel (NYSE: X ) and AK Steel (NYSE: AKS ) have found it hard to deal with narrow margins and cheap imports.
Those problems have rippled out across the entire group of materials suppliers. In iron ore, Brazil's Vale (NYSE: VALE ) has seen Chinese demand dry up significantly, leading to severe share-price compression. Meanwhile, coal stocks across the industry have suffered greatly, with Patriot Coal having to declare bankruptcy and Arch Coal (NYSE: ACI ) losing about 80% of its share value over the past year as demand on both the thermal and metallurgical sides of the business has fallen in light of low natural gas prices and weaker levels of construction activity.
Long term, it's hard to argue that iron ore and coal aren't going to play key roles in global expansion. But, as the cycle turns, now appears to be a time in which Cliffs and its peers will struggle for survival. The winners, though, should emerge stronger than ever.
For retirees and other conservative investors, the question is whether you have the time and risk tolerance to wait out what could be a long cyclical downturn. For those who do, however, the rewards could be substantial, and Cliffs could be a great play for a global economic recovery a few years down the road.
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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