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.
No company has a more all-encompassing reach into the health-care industry than Johnson & Johnson
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 Johnson & Johnson.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$177 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||3 years||Fail|
|Free cash flow growth > 0% in at least four of past five years||2 years||Fail|
|Stock stability||Beta < 0.9||0.53||Pass|
|Worst loss in past five years no greater than 20%||(7.7%)||Pass|
|Valuation||Normalized P/E < 18||20.82||Fail|
|Dividends||Current yield > 2%||3.5%||Pass|
|5-year dividend growth > 10%||9.1%||Fail|
|Streak of dividend increases >= 10 years||49 years||Pass|
|Payout ratio < 75%||63.6%||Pass|
|Total score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Johnson & Johnson last year, the company has fallen by two points. A slight decline in J&J's dividend growth rate isn't a huge cause for concern, but a much higher valuation and another failure to grow free cash flow aren't the best signs for the stock.
J&J has a long history of solid growth. Until 2009, the company sported a record of annual sales gains that spanned more than three-quarters of a century. But then, a combination of a weak economy cutting demand for medical devices, loss of patent protection on some key drugs, and product recalls on the consumer side led to revenue losses. Patients fled to Merck
But the big news for J&J going forward is next month's departure of decade-long CEO Bill Weldon. That'll be vital for the company to regain some of its lost luster from consumer product recalls, especially in light of new competition coming. Perhaps sensing weakness, a joint venture between generic-drug maker Teva Pharmaceutical
For retirees and other conservative investors, a quickly rising payout ratio may actually be the biggest concern. With a dividend yield of 3.5%, shareholders should be content for now. But if that yield starts to erode, then you can expect the goodwill that J&J has produced over the years to disappear fairly quickly.
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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Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Procter & Gamble, Pfizer, Johnson & Johnson, and Teva Pharmaceutical, as well as creating a diagonal call position in Johnson & Johnson. 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 Fool has a disclosure policy.