Roth IRAs offer a lot of advantages that make them great investment tools for retirement savings. Unlike traditional IRAs, they don't require minimum distributions in your golden years, and they can provide advantages for legacy planning, too. Perhaps their biggest advantage, however, is their ability to receive dividend payments that can grow tax-free. Because of that perk, our Fools think Cisco Systems (CSCO 0.67%), Pfizer, Inc. (PFE -0.12%), and Enviva Partners (EVA) are savvy stocks for your Roth IRA.
Growth potential and a great dividend
Keith Noonan (Cisco Systems): Dividend-paying stocks tend to be good candidates for Roth IRAs because generated income can accumulate and be reinvested tax-free. Cisco Systems stands out as an especially strong option because it packs significant growth potential in addition to its attractive returned income component.
Image source: Getty Images.
The leader in enterprise networking solutions boasts a chunky 3.4% yield, and with the expense of distributing its dividend representing roughly 47% of its trailing free cash flow, there's still room for future payout increases. Cisco has raised its payout each year since it began paying a dividend in 2011 and has boosted its payout at an average annual rate of 27.7% over the stretch, most recently announcing an 11.5% increase. Payout growth might slow as the company invests in new business avenues and endures pains related to its transformation, but its dividend profile is already very strong.
Cisco stock has gained roughly 25% over the last year, but pressures facing its core routing and switching hardware businesses continue to be cause for some pessimism surrounding the company's outlook. Concerns about its transition to a more software-and-service-focused model mean that investors can still buy the company at an attractive price.
Trading at roughly 14 times forward earnings estimates, Cisco stock looks cheap in the context of the networking and communications industry average forward P/E of roughly 25 and the S&P 500's forward P/E of 18. Cisco looks primed for substantial long-term growth potential if it continues to successfully build its cloud, security, and software offerings.
This drugmaker has proven itself in tough times
Todd Campbell (Pfizer, Inc.): I like owning stocks for the long haul that have proven they know how to navigate tough times, and perhaps no company has proven that more to me than biopharma giant Pfizer.
After losing patent protection on its top-selling cholesterol drug, Lipitor, Pfizer's revenue tumbled to $50 billion from a peak of $65 billion 10 years ago. That's a tough pill to swallow, but selling non-core assets, reinvesting in its research and development pipeline, acquiring up-and-coming competitors, and keeping a lid on its costs has positioned Pfizer perfectly for growth now that Lipitor headwinds are abating.
In spite of its revenue drop, Pfizer has maintained operating margin of about 25% since 2014, and now that revenue is showing signs of expanding again, I think there's a big opportunity for margin to head higher.
PFE Operating Margin (TTM) data by YCharts.
A return to growth is due in part to top-selling drugs, including the blockbuster breast cancer drug Ibrance and the anticoagulant Eliquis. Growth also benefits from acquisitions that have made Pfizer a leader in the emerging market for biosimilars, as well as in prostate cancer treatment.
Pfizer's rock-solid balance sheet sports $25 billion in cash and investments, and with operating cash flow of $16 billion (and growing), there appears to be plenty of dough to hike dividend payments. Currently, shares already yield a respectable 3.7%, and if I'm correct, then this company could produce a steady stream of increasing income that can compound tax-free in a Roth IRA over the coming decades.
Get that reliable return in your Roth
Brian Stoffel (Enviva Partners): I'm not a dividend investor at heart, but sometimes, there are payouts that are hard for me to ignore. One tiny company that I'm considering buying for my own Roth IRA is Enviva Partners. In general, I think it's wise to put dividend payers in your Roth -- as opposed to a traditional IRA -- because you are guaranteed to pay zero taxes on whatever payouts you receive. While capital appreciation isn't guaranteed, payouts are much more likely.
I've written more extensively about Enviva recently, but the elevator pitch is pretty simple. The company has consolidated the wood pellet market in the Southeastern United States. While that may seem like a niche product, it's big business in Northern Europe, where power companies need to find new inputs to replace coal in order to meet more stringent environmental standards.
Enviva owns a number of production plants and a deep-water dock in the Port of Chesepeake that help cut down on transportation and production costs. Because Enviva signs long-term contracts with these European power companies -- the average contract is just under 10 years -- revenue is fairly predictable. It is through efficiency improvements that distributable cash flow (DCF) is able to increase.
Currently, Enviva's management expects to offer $2.35 per share in distributions in 2017. At today's prices, that's equivalent to an 8% yield. The company's goal is to use 87% or less of DCF to pay its outsized dividend, but last year it came in even better -- eating up just 78% of DCF.
Trading at just nine times expected DCF in 2017, I think this tiny company deserves consideration in your Roth IRA.
