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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.
Everybody likes to save money, but during the recession a few years ago, it became a necessity for millions of Americans. Even low-end retailers found themselves struggling to keep cash-strapped customers coming into the stores. But for Family Dollar (NYSE: FDO ) , the weak economic environment was perfectly aligned with its business model of catering to deep-discount shoppers. If the recovery is for real, though, can the dollar-store giant keep its gains? Below, we'll revisit how Family Dollar 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 Family Dollar.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$7.7 billion||Fail|
|Consistency||Revenue growth > 0% in at least four of past five years||5 years||Pass|
|Free cash flow growth > 0% in at least four of past five years||3 years||Fail|
|Stock stability||Beta < 0.9||0.24||Pass|
|Worst loss in past five years no greater than 20%||(33.3%)||Fail|
|Valuation||Normalized P/E < 18||18.46||Fail|
|Dividends||Current yield > 2%||1.3%||Fail|
|5-year dividend growth > 10%||5.9%||Fail|
|Streak of dividend increases >= 10 years||36 years||Pass|
|Payout ratio < 75%||21.6%||Pass|
|Total score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Family Dollar last year, the company has had its score plunge by three points. A drop in free cash flow as well as slowing dividend growth and richer valuations caused the drop, even as the stock posted an impressive 30% gain over the past year.
Dollar stores have come a long way in recent years. During the worst of the recession, Family Dollar, Dollar Tree (Nasdaq: DLTR ) , Dollar General (NYSE: DG ) , and a host of other deep-discount retailers blossomed as consumers sought ways to move down to the lowest price points possible. Even Wal-Mart (NYSE: WMT ) , the perennial discount retailer, saw customer defections at the hands of Family Dollar and its peers.
But since then, dollar stores have realized that they need to include higher-end discretionary items in order to keep margins up. The extent to which the stores can be successful with those products goes a long way toward determining their overall profitability.
The big danger that Family Dollar faces is overconfidence. As Fool analyst Bryan Hinmon noted a few months ago, dollar stores have little ability to raise prices, leaving them with store expansion as their biggest growth driver. Yet with Big Lots (NYSE: BIG ) and other competitors also seeking to expand, Family Dollar can only add so many stores before it runs into market saturation.
Still, Family Dollar hasn't hit the saturation point yet. Just yesterday, Family Dollar reported record sales and earnings in its fiscal fourth quarter. With same-store sales rising 5.4%, it's clear that consumers aren't giving up on the deep-discount concept. CEO Howard Levine pointed to expanded product offerings in areas like tobacco, beauty aids, and gift cards as a key driver of success.
For retirees and other conservative investors, Family Dollar's 36-year history of increasing dividends is a definite mark in its favor. But with valuations getting on the high side and a dividend yield that's tepid at best, you'll probably want to look elsewhere for a stock to add 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.
If you really want to retire rich, no one stock will get the job done. Instead, you need to know how to prepare for your golden years. The Motley Fool's latest special report will give you all the details you need to get a smart investing plan going, plus it reveals three smart stocks for a rich retirement. But don't waste another minute -- click here and read it today.
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