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.
Utilities have long been attractive companies for conservative investors. But waves of change in the utility industry have made it more important than ever to know exactly what a utility does. FirstEnergy (NYSE: FE ) serves the mid-Atlantic region, with a recent push into the Midwest. Can it overcome some of the fierce resistance it has found there from competitors? Below, we'll revisit how FirstEnergy 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 FirstEnergy.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$18.1 billion||Pass|
|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||0.43||Pass|
|Worst loss in past five years no greater than 20%||(30.6%)||Fail|
|Valuation||Normalized P/E < 18||16.38||Pass|
|Dividends||Current yield > 2%||5.1%||Pass|
|5-year dividend growth > 10%||2.4%||Fail|
|Streak of dividend increases >= 10 years||0 years||Fail|
|Payout ratio < 75%||82.0%||Fail|
|Total score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at FirstEnergy last year, the company has kept its five-point score. But the stock has lost a bit of ground in the past year as the utility has dealt with a troubled environment for the industry.
Until very recently, FirstEnergy was on top of the world. Huge revenue and earnings gains in the first quarter of 2012 helped highlight its place at the top of the power-generation business, with peers Exelon (NYSE: EXC ) and NRG Energy having fallen behind, perhaps in part due to their greater exposure to nuclear power. Meanwhile, investors seeking high levels of dividend income boosted popularity of the stock, which tops Southern Company (NYSE: SO ) and several of its utility peers in terms of yield.
But, last month things turned bad for FirstEnergy. Earnings slipped from last year's levels and fell below analyst estimates, with lower wholesale power prices and falling margins combining to create the problem. The utility still held its full-year guidance steady, but investors weren't convinced, sending the stock sharply lower.
Part of the challenge FirstEnergy faces is balancing its coal-fired and gas-fired production capacity. The company plans to keep an Ohio River coal-fired plant idle until demand increases. PPL (NYSE: PPL ) is considering similar moves, while American Electric Power (NYSE: AEP ) has already done so.
For retirees and other conservative investors, it's tough to find too much fault with FirstEnergy, which has seen its dividend payout ratio fall dramatically in the past year despite staying above the 75% mark. With a 5% yield, you may be getting enough of a reward to justify taking the risk of adding FirstEnergy to your retirement 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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