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.
The housing bust has destroyed entire swaths of the U.S. economy. From homebuilding stocks to mortgage lenders, once-thriving industries are still struggling to survive and recover. Yet while it would have been reasonable to expect home improvement retailer Home Depot
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 Home Depot.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$74.6 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||2 years||Fail|
|Free cash flow growth > 0% in at least four of past five years||3 years||Fail|
|Stock stability||Beta < 0.9||0.79||Pass|
|Worst loss in past five years no greater than 20%||(31.1%)||Fail|
|Valuation||Normalized P/E < 18||19.05||Fail|
|Dividends||Current yield > 2%||2.4%||Pass|
|5-year dividend growth > 10%||6.3%||Fail|
|Streak of dividend increases >= 10 years||3 years||Fail|
|Payout ratio < 75%||40.7%||Pass|
|Total score||4 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Home Depot last year, the company has dropped two points. Slowing dividend growth and a big increase in its earnings multiple hurt Home Depot's score, although few investors will complain about a 40% jump in its shares in a largely flat market overall.
For years, Home Depot has demonstrated how share prices don't necessarily match up with business conditions. Even though the stock has rebounded sharply from its financial-crisis lows, Home Depot's business has suffered for years, as a weak environment hurt the company and archrival Lowe's
But 2011 was a strong rebuilding year for Home Depot. Some signs of life in the housing market helped reawaken interest in the space, with niche providers Lumber Liquidators
More recently, though, concerns in the industry are on the rise once more. Late last month, Lowe's gave cautious guidance immediately after Home Depot reported sales that missed analyst estimates. The past month has also brought huge declines for homebuilders, as PulteGroup
For retirees and other conservative investors, Home Depot has enjoyed a huge bull run in anticipation of an improving industry. If that improvement ends up getting delayed, now could prove to be a disastrous time to buy the stock. Risk-averse investors should look at the more cheaply priced Lowe's or wait for a better opportunity to buy the stock at a lower price.
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. The Motley Fool owns shares of Lumber Liquidators. Motley Fool newsletter services have recommended buying shares of Home Depot and Lumber Liquidators, as well as writing covered calls on Lowe's. 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.