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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.
Costco (Nasdaq: COST ) has the unusual distinction of being one of only a few companies to completely transform an industry. Before Costco, the world of warehouse purchasing was mainly reserved for wholesale buyers looking for goods to resell. But Costco changed all that, making its warehouse stores a mecca for bargain-conscious consumers willing to buy in bulk. Now that so many competitors have jumped on the bandwagon, though, can Costco hold on to its competitive advantage? Below, we'll revisit how Costco 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 Costco.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$43.0 billion||Pass|
|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||2 years||Fail|
|Stock stability||Beta < 0.9||0.69||Pass|
|Worst loss in past five years no greater than 20%||(24.0%)||Fail|
|Valuation||Normalized P/E < 18||27.29||Fail|
|Dividends||Current yield > 2%||1.1%||Fail|
|5-year dividend growth > 10%||13.2%||Pass|
|Streak of dividend increases >= 10 years||9 years||Fail|
|Payout ratio < 75%||26.6%||Pass|
|Total score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Costco last year, the company has kept its five-point score. But shareholders aren't planning to return their shares for a refund anytime soon, with the stock having picked up almost 25% in the past year.
Costco's business model has turned the retail world upside down. While many retailers have long sought to maximize profit margins, Costco embraces razor-thin margins and makes it up on volume by selling just about everything imaginable. That theme has resonated with shoppers, who've abandoned Best Buy (NYSE: BBY ) and other specialty retailers in the electronics and office supply areas. It's even proven successful overseas, with Costco's former sibling PriceSmart (Nasdaq: PSMT ) using a similar business model in Central America and the Caribbean.
But even Costco faces potential disruptors. Amazon.com (Nasdaq: AMZN ) is the obvious leader, with its online retail model that not only offers rock-bottom prices on a wide variety of goods but also delivers them, in many cases free of charge. Meanwhile, Wal-Mart (NYSE: WMT ) remains in the hunt with both its flagship stores and its Sam's Club copycat warehouses.
Costco also needs consumers to feel comfortable enough to buy. Otherwise, the company is susceptible to buying too much of certain products while leaving its customers too intimidated by their sheer size to take them off the shelves.
For retirees and other conservative investors, Costco's valuation is more expensive than most would prefer to see, and its dividend yield is fairly skinny. The retailer has had an impressive run, but you may do better waiting for a pullback rather than chasing Costco's shares for your retirement portfolio at these levels.
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.
Costco will face challenges from Amazon for the foreseeable future. That makes it essential for Costco investors to learn everything they can about the online retail giant. Get the entire scoop from the Fool's top analysts as they take an in-depth look at the extraordinary store chain in the Fool's premium report on Amazon. It's there for the taking, so don't wait -- buy it today.
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