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.
Look at a stock chart of ITT (NYSE: ITT ) and you might think that some cataclysmic event must have taken place to justify the huge drop in its share price over the past year. But in reality, the company has transformed itself, spinning off some of the businesses under its former conglomerate umbrella to focus on its industrial engineering business. Will that help the surviving company move in the right direction? Below, we'll revisit how ITT 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 ITT.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$1.8 billion||Fail|
|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||2 years||Fail|
|Stock stability||Beta < 0.9||1.12||Fail|
|Worst loss in past five years no greater than 20%||(29.5%)*||Fail|
|Valuation||Normalized P/E < 18||13.72||Pass|
|Dividends||Current yield > 2%||1.8%||Fail|
|5-year dividend growth > 10%||(5.0%)||Fail|
|Streak of dividend increases >= 10 years||0 years||Fail|
|Payout ratio < 75%||NM||NM|
|Total score||2 out of 9|
Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes. * Reflects adjustment for spinoffs.
Since we looked at ITT last year, the company has seen its score drop three points. But the big changes in ITT's corporate structure make it very difficult to compare the company with what it looked like last year.
Late last year, ITT split itself into three parts. Exelis (NYSE: XLS ) took ITT's defense business and continues building electronics, geospatial, and mission systems for the military. Meanwhile, Xylem (NYSE: XYL ) provides water-related technology, dealing with issues ranging from water and wastewater treatment to heat transfer and beverage serving.
But ITT continues as an engineering firm, hoping to add value to its products by incorporating its intellectual property into the products themselves. With these "highly engineered" products, ITT hopes to stave off competition from Honeywell (NYSE: HON ) , Danaher (NYSE: DHR ) , and a host of other rivals in key niche areas. Honeywell in particular has benefited from a big jump in aircraft-related sales, while Danaher has been on an acquisition binge that has boosted its presence in the health-care technology and equipment field.
So far, the move seems to be going fairly well for ITT. In its most recent quarter, the company managed to grow sales 3% versus the prior year, with earnings beating estimates.
Still, for retirees and other conservative investors, the jury's still out over which of ITT's three continuing components makes the best investment. ITT may benefit from having its defense division separate, but with the somewhat noncyclical water business now spun off, ITT will likely see more volatility. That makes the stock somewhat risky for a retirement portfolio, despite a decent valuation. Only if you're willing to take on a decent amount of risk should you consider ITT for your portfolio.
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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