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.
Around the world, telecom stocks offer some of the best yields around. But the industry has changed a lot, making telecom far from the riskless, utility-like proposition it once was. As France Telecom's (NYSE: FTE ) experience proves, the industry has gotten cutthroat-competitive, and poor economic conditions threaten companies that do a lot of business in Europe. Can France Telecom survive a European recession and come out stronger on the other side? Below, we'll revisit how France Telecom 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 France Telecom.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$33.7 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||3 years||Fail|
|Free cash flow growth > 0% in at least four of past five years||2 years||Fail|
|Stock stability||Beta < 0.9||0.32||Pass|
|Worst loss in past five years no greater than 20%||(16.6%)||Pass|
|Valuation||Normalized P/E < 18||6.56||Pass|
|Dividends||Current yield > 2%||14%||Pass|
|5-year dividend growth > 10%||2.8%||Fail|
|Streak of dividend increases >= 10 years||0 years||Fail|
|Payout ratio < 75%||100%||Fail|
|Total score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes. Dividend information based on trailing payout.
Since we looked at France Telecom last year, the company has dropped a point. A year of falling revenue and free cash flow cost the company in the score column even as its share price has fallen more than 20% over the past year before considering its lucrative dividend.
Like many industry peers, France Telecom produces a lot of cash flow, and historically, it has directed much of that cash back to shareholders through dividends. That explains the company's double-digit dividend yield, which at the moment is higher even than cash-flow-rich U.S. rural telecoms Windstream (Nasdaq: WIN ) and Frontier Communications (Nasdaq: FTE ) .
But with both Frontier having reduced its payout twice since 2010 and France Telecom's European peer Telefonica (NYSE: TEF ) having suspended its dividend, many wonder if France Telecom will be next to make a cut. Even after shareholders voted to keep France Telecom's dividend stable earlier this year, the company may still have to push the payout lower in the near future. One analyst expects a cut of nearly 50% by 2013 to direct more of the company's cash flow toward paying down debt.
Still, France Telecom is trying to improve. It partnered with Intel (Nasdaq: INTC ) as the processor giant tries to advance into the mobile market. Yet until Europe truly turns around, it'll be tough for France Telecom to emerge fully from its doldrums.
For retirees and other conservative investors, the shoe is waiting to drop on France Telecom's dividend, which is the stock's most attractive quality at the moment. Once investors know what the future holds for the stock's payout, it'll be easier to tell whether France Telecom really deserves a place in retirement portfolios.
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.
To get a hint as to what a lower-dividend France Telecom might look like, just look at Frontier. You can learn more about the rural telecom giant in the Fool's premium report on Frontier Communications. It'll help you gain a better understanding of the industry generally, so don't wait: Click here and read it today.
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