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3 Great Stocks for Your Roth IRA

By Timothy Green – Nov 17, 2016 at 9:21AM

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Take full advantage of the tax benefits with these three dividend stocks.

Image source: Getty Images.

While you won't get a tax deduction for contributing to a Roth IRA, your future self will thank you. Your money grows tax-free in a Roth IRA, and distributions after reaching the required age go straight into your pocket without Uncle Sam taking a cut. This setup makes buying dividend stocks a great Roth IRA strategy.

But don't just throw any old dividend stock into your Roth IRA. You want companies that are going to be around a few decades from now. And while collecting dividends tax-free is great, combining those dividends with the potential for capital appreciation can supercharge your retirement portfolio. Here's why International Business Machines (IBM -0.38%), McDonald's (MCD 0.13%), and General Motors (GM 0.81%) are great stocks for your Roth IRA.

105 years and counting

IBM has been around for a long time. Well before computers, IBM was solving problems for businesses, selling and leasing mechanical tabulating machines that crunched what was an incredible amount of data at the time. The company has transformed itself multiple times over its long life, and some of those transitions have been painful. But adaptation is in the company's DNA, something that should be reassuring to long-term investors.

Image source: IBM.

IBM is going through another transformation at the moment, aiming to become a cloud and cognitive computing powerhouse. Revenue and profits have been in decline, but the company still churns out cash at an impressive rate. This allows IBM to spend billions of dollars each year buying back its own shares in addition to paying an attractive dividend. IBM stock yields about 3.5%, a higher yield than many of its peers.

IBM stock trades for less than 12 times the company's earnings guidance for this year, a price that bakes in quite a bit of pessimism. Investors patient enough to stick with IBM through its transition will benefit if and when the company returns to growth, and that fat dividend payment is a nice bonus. IBM is a dividend stock that could soar if things go right, making it ideal for a Roth IRA.

Serving up new growth

The restaurant business is more competitive than ever, requiring McDonald's to make some big changes. The company is moving away from artificial preservatives, removing those ingredients from many of its menu items. High fructose corn syrup is being taken out of its buns, and antibiotic-free chicken will be the standard early next year. Breakfast items are now served all day long, ending the tyranny of the 10:30 a.m. cutoff once and for all.

Image source: McDonald's.

All of these changes have led to solid results for the restaurant chain. Comparable sales are growing again, with McDonald's posting growth of 3.5% during the third quarter. Profits are on the rise, driven by higher comparable sales and the company's ongoing refranchising efforts. And the stock, after stagnating for a few years, has surged.

McDonald's isn't the cheapest stock around, trading for around 21 times analyst estimates for earnings this year. But a 3.2% dividend yield makes the stock an attractive pick for a Roth IRA. McDonald's is proving that it can adapt to changing consumer preferences. That's good news for long-term investors.

A dividend bonanza

General Motors is a dividend investor's dream. The stock sports a 4.5% yield, trades for a single-digit multiple of earnings, and has a payout ratio, based on the company's earnings guidance, of just 25%. To be fair, GM's earnings may decline going forward, driven by plateauing demand for automobiles in the United States. That low valuation is justified to a degree given this reality, but I still think the market is being overly pessimistic.

Image source: General Motors.

GM's third-quarter results demonstrate how well the company is doing. Revenue rose 10.3%, adjusted operating income rose 14.4%, and adjusted return on invested capital surpassed 30%. This solid performance was despite profitability issues in both Europe and South America, markets where GM continues to operate in the red.

With the election of Donald Trump, uncertainty surrounding GM has increased. The possibility of tariffs and the end of NAFTA have the potential to cost the U.S. auto industry billions. GM's bargain valuation provides some protection against that scenario, but it's something that investors need to keep in mind. In the long run, the industry should be able to adapt to whatever environment it finds itself in. Despite the uncertainty, GM still looks like a great Roth IRA stock.

Timothy Green owns shares of General Motors and IBM. The Motley Fool recommends General Motors. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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