OK, those of us in our 60s know this already, but I'm going to say it anyway: We are not old. "Old" people are 10 or more years older than us, a perspective we've probably held for a long time -- say, since our first rock concert in the 1960s.
I'm not just being whimsical about this; I have data. The Pew Research Center conducted a study of aging and found that the definition of old age depends on who you ask. People between 18 to 29 think that the average person becomes old at age 60. Those of middle age believe the threshold is closer to 70, and people 65 and older -- the ones who ought to know, I might add -- say on the average that old age starts at 74.
Well, I admit that how we feel about aging might not matter much in investing, but what does matter is longevity. A woman turning 65 in the U.S. today can expect to live, on average, to 86.6. A man can expect to live to 84.3. And perhaps even more important is the fact that 1 out of every 4 65-year-old Americans will live to 90 and 1 in 10 will live to 95.
What that means for us is that the investment horizon of a 60-something is still measured in decades. That has implications for how we should look at picking stocks. Ask a 30-something (you know, one of those people who think we are old) what stocks a 60-year-old should own, and it's almost a certainty they'll say to go with dividend stocks. That would be the conventional wisdom, but it misses the most important point.
Don't get me wrong: I think dividend stocks are great for people of all ages. Leaders of companies that emphasize dividend yield tend to have a conservative mindset, not taking risks that could force a dividend cut down the road. Often this leads to steadier performance, less volatility, and an investment you don't have to watch very closely. And if you are drawing on your portfolio regularly for income, those dividend credits coming into your account are nice to see.
But the real enemy of older investors that are living on investment income is not volatility, it is inflation. Even at a low inflation rate of 3%, a 65-year-old needs to prepare for the possibility of inflation doubling their cost of living in their lifetime. And there is no guarantee that inflation won't return to the higher rates of yesteryear (consider the Jimmy Carter years).
So the best stocks for people in their 60s include a component of growth that will at least keep up with inflation. American Tower Corporation (AMT -2.47%), 3M Corporation (MMM -1.86%), and Celgene (CELG) are three stocks with good growth and some built-in inflation protection (and yes, two of them happen to pay dividends).
American Tower Corporation
American Tower owns cellphone towers -- lots of them. It owns about 40,000 towers in the U.S. and 108,000 in the rest of the world, mostly in the emerging markets of India, Africa, and Latin America, where cellphone coverage is growing rapidly.
American Tower makes its money by renting space on its towers to communications companies. A single tower could have space rented to multiple phone companies, and each tenant could have multiple sets of antennas and equipment for different wireless technologies and frequencies. As cellular voice and data usage increases, tenants add more equipment to increase bandwidth, and have to pay American Tower more rent.
The beauty of American Tower's business model, and why it has inflation protection built in, is that the company signs contracts with tenants for five to 10 years with built-in escalation clauses that raise the rent at about the rate of inflation. In the U.S., these escalators average about 3% annually, and in international markets, the rate is based on local inflation rates. Tenants typically renew; the historical churn rate is about 1% to 2%.
The rate escalations protect revenue from inflation, increasing cellular data usage drives the need for more equipment space and therefore more rent, and the company has other sources of growth, too. The company is structured as a real estate investment trust (REIT), so it is required to return 90% of its GAAP profit as distributions to shareholders. But since the company has a lot of non-cash expenses, it generates free cash flow far in excess of what it needs to distribute, and it uses that money to expand, buying new tower sites or acquiring towers from other providers. It also helps to support a dividend yield of 2%.
With mobile data usage expected to expand at least 25% to 30% annually in the U.S. (and even faster in emerging markets), and deployment of 5G equipment on the horizon, American Tower has plenty of growth to layer on top of its inflation-protected core. The stock yields 2%.
It's hard to find a company that has a more reliable history of growth and investor-friendly capital allocation than 3M. It has paid a dividend for a hundred years and recently joined a small group of companies that has raised their dividend each year for the last 60 years.
These haven't been token raises. Over the last 20 years, 3M has raised its quarterly dividend by 395%, outpacing inflation over that period of 52% by almost eight times. That kind of income growth can help retirees sleep at night.
What makes 3M able to deliver returns that beat inflation by a wide margin over decades? Innovation. The company consistently invests in innovation, both in new products and in manufacturing processes, and has a large product portfolio diversified across multiple sectors like consumer goods, healthcare, and industrial, giving it stability and dependability.
Last year 3M grew sales 5.1%, increased core earnings 12.4%, converted 100% of earnings to free cash flow, paid out $2.8 billion in dividends, and bought back $2.1 billion of its stock. It recently hiked the dividend by a whopping 16%. The stock now yields 2.3% and sells for a reasonable 22 times estimated 2018 earnings.
Count on 3M to continue delivering inflation-beating returns long after you get old.
No doubt you've noticed, either through personal experience or by reading the news, that drug prices are rising much faster than inflation. Industry forecasters predict that drug prices will increase 7.6% in 2018, more than three times the 2% overall inflation the Federal Reserve is expecting. Politicians may talk about the issue a lot, but no one seriously believes that drug prices will do anything but soar relative to inflation for a long time.
Fueling the growth of the drug industry is billions of dollars in spending on research and development, which is producing new breakthrough therapies and discovering treatments for diseases that were formerly untreatable. Investors can get growth with some inflation protection by buying shares of companies that have plenty of cash flow to pour into developing their drug pipeplines.
Celgene, one of the larger biotechnology companies, spent $2.7 billion on research and development in 2017. That's not enough to put it in the top 10 spenders in the drug industry, but it's growing that investment faster than its peers, having hiked its R&D budget 9.6% from the year before. Celgene is running 160 clinical trials with 42 novel molecules across 60 indications.
Celgene's current drug portfolio is generating plenty of growth and cash flow, which will be used for drug development and strategic acquisitions like its recent offer to buy Juno Therapeutics. Sales in 2017 grew 16% last year to $13 billion and adjusted earnings per share grew 25%. Operating cash flow of $5.2 billion was up 26% compared with 2016. Analysts expect the company to be able to grow prescription drug sales at 15% annually through 2022.
You can get a piece of Celgene on sale now. A clinical trial failure last fall got investors worried about the near-term outlook, but Celgene's robust pipeline and growing investments in new drugs will produce plenty of other blockbuster drugs in the investment horizon of a 60-something. The stock sells for 11 times estimated 2018 earnings, compared with 17x for the S&P 500. Celgene doesn't pay a dividend, preferring to invest its cash in its business.
Dividends aren't enough
Dividend stocks are great for people in their 60s, but every dollar that a company returns in the form of a dividend is a dollar that it does not reinvest in growing the underlying business. That's fine, but to withstand the inflation threat, those of us relying on investments to sustain us for decades need to make sure our investments also come with dependable sources of growth as well.
Hey, if you're in your 60s, don't let anyone tell you you're old. Instead, buy good growth stocks that can beat inflation over the long term and be patient. Because, chances are, someday you will be old. Of course, you already knew that.