Electrical products and power management company Eaton (NYSE:ETN) -- up nearly 38% on a year to date basis as I write -- was arguably the best stock of the year if you're a retiree. The company is far from being the most exciting stock on the market, but boring should do just fine for investors looking for a reliable stream of income in their old age. Here's how Eaton made it to the top of the list and why it's still an attractive investment for 2020.

A man pointing at a rising bar chart.

Image source: Getty Images.

Stock screening for dividend stocks

First, a few words on the selection process -- not least so readers can perform such exercises themselves in the future. Using commonly available stock screeners, the following filters can be used to whittle down the universe of suitable stocks. For reference, this is not a list of the only suitable stocks for retirees, just ones that performed the best in 2019 within certain parameters -- there are many other ways to find stocks suitable for retirees

As outlined below, I've looked for stocks with a current yield in excess of 3% and manageable debt with good dividend coverage.

Filter

Metric Explanation

Rationale

Stocks Left After Filter Applied

Market Cap Above $2 billion

Price times shares listed

Need for liquidity in a stock

837

Dividend Yield Above 3%

Dividend divided by price

Need for a decent income

165

Return on Equity Above 10%

Net income divided by shareholders equity

Retirement stocks must have growth potential

100

Long-Term Debt to Equity Below 60%

Long-term debt divided by equity

Debt can become a significant issue in a recession

24

Current Ratio Above 1

Current assets divided by current liabilities

Company must have good liquidity

10

Payout Ratio Less Than 75%

Dividend divided by earnings

Flexibility to grow the dividend

4

Data source: Author's analysis using macrotrends.com stock screener.

The four final candidates are shown below. It can immediately be seen that Eaton and asset manager Eaton Vance (NYSE:EV) were the best performers in 2019.

ETN Chart

ETN data by YCharts

I'll focus on Eaton in a moment, but it's worth noting that the two technology also-rans, namely telecommunications equipment company Cisco Systems (NASDAQ:CSCO) and integrated circuit maker Maxim Integrated Products (NASDAQ:MXIM) are companies that many investors would dismiss as candidates for a retirement portfolio in any case.

Cisco is a worthy company, but to buy the stock for the long term, you need to be confident in the long-term future for its switches and routers as internet infrastructure moves away from the enterprise level toward the cloud.

Similarly, Maxim Integrated is an exciting company, especially as the Internet of Things (IoT) looks set to spur ever more increasing use of electronics in automobiles, and in industrial and consumer products. However, it's a highly competitive field and Maxim comes up against far larger semiconductor companies like Analog Devices and Texas Instruments -- a concern in a highly cyclical industry where scale is so important.

Meanwhile, Eaton Vance is an investment asset manager -- a great business to be in when the markets are in good shape and assets under management are expanding. However, Eaton Vance's management fees will always be subject to the underlying performance of equity and fixed income markets -- nearly half of its management fees come from assets under management held in equities.

A less risky choice

Eaton is also a somewhat cyclical company, but it has a relatively diverse collection of end markets ranging from utilities, trucks, and aerospace to industrial factories, data centers, and construction. In fact, Eaton's lower risk profile is reflected in the following metrics.

The standard deviation of monthly returns is simply a mathematical representation of how much a stock's monthly return tends to vary from its average. A lower number is better, as it implies the stock is less volatile. As you can see below, Eaton's is significantly lower than the others.

In addition, I've included the "Sharpe ratio," which simply takes returns generated in excess of a risk-free rate and then divides it by standard deviation -- a higher number is better. From this you can measure whether a company is making its returns through being more risky. Again, Eaton scores relatively well.

MXIM Historical Sharpe Ratio (10Y) Chart

MXIM Historical Sharpe Ratio (10Y) data by YCharts

There's a reason why Eaton has done so well, and that comes down to operational improvements over the years. In a nutshell, a series of restructuring actions and acquisitions have significantly improved its margin and free cash flow generation in the last decade.

ETN Operating Margin (TTM) Chart

ETN Operating Margin (TTM) data by YCharts

Indeed, management expects to generate some $8 billion in free cash flow between 2019-2021, a figure representing around 20% of the current market cap with low-single-digit growth in revenue and earnings. After dividend payments of $3.5 billion, Eaton should have around $4.5 billion of cash available (around 11% of its current market cap) with which to make share repurchases or acquisitions -- another source of earnings growth potential.

Eaton is a good stock for retirees

Not only was Eaton the best retirement stock for investors in 2019, but it also has plenty of potential to do well for investors in the coming years. The dividend is very well covered and the company's cash flow generation, ongoing restructuring, and relatively diverse end markets suggest it can grow its dividend for many years to come.