Back in 1965, you would be hard-pressed to find a real technology company in the S&P 500. Fast-forward to 2015, and those businesses now make up 20% of the famous benchmark.
But a great technology company does not always make for a great technology stock. While some tech stocks represent pieces of high-quality companies, they may not be suitable for a typical retirement portfolio. That is because capital preservation is so important when you are drawing down your nest egg.
Brian Stoffel (Baidu)
Baidu is the parent of the largest search engine in China. I am a huge fan of the stock -- it makes up a whopping 13% of my real-life holdings. But right now, I am just 33 years old, and I have another three decades before I will be able to start collecting Social Security.
If my parents -- who are on the cusp of retirement -- were to ask if they should invest heavily in Baidu, I would steer them somewhere else. I have two reasons for doing this:
First, Baidu relies heavily on China for virtually all of its revenue. Though the company has begun dipping its toes in other markets, advertising dollars from China still make up the lion's share of revenue. Even if it was unwarranted, signs of a slowing economy in China would cause the stock to take a hit -- which would create a problem if a retiree needed to sell shares for living expenses.
More importantly, it is easy to forget that Baidu still operates under a Communist regime. Though there are no overt signs of hostility between Baidu and government leaders, the regime has the power to censor the company or take control of it altogether -- leaving shareholders with little to show for their investment.
Trading at 36 times trailing earnings, that is too much risk for retirees to take.
Bob Ciura (Facebook)
This is one of the most widely followed growth stocks, and for good reason. Facebook is the dominant player in social media with more than 1.3 billion global monthly active users as of the end of 2014. As it keeps racking up additional users, its growth is exploding. Revenue grew 58% last year, and EPS jumped 83%. As a result, the stock soared more than 40% during that period.
But when I think of the best stocks for retirees, Facebook does not fit the mold. Typically, one of the primary concerns for retirees is replacing lost income from being out of the workforce. Facebook does not pay a dividend, so retirees looking for income will be disappointed.
Additionally, as Facebook is a highly touted growth stock, it commands a very lofty valuation. Shares of Facebook trade for 70 times trailing earnings and 32 times forward earnings estimates. By comparison, the broad S&P 500 averages 20 times trailing earnings. To be sure, Facebook may have little trouble growing profits fast enough to justify this valuation, but it leaves little room for error.
With no dividend and a lofty valuation, Facebook investors are not getting much of a margin of safety in case things do not go according to plan. Retirees have a particular set of needs -- usually income generation and protection of principal. They generally have a shorter time horizon than younger investors, meaning if Facebook corrects, as high-fliers often do, they cannot afford to wait.
While Facebook is a great growth stock, it does not look like an appropriate investment for retirees.
Andres Cardenal (LinkedIn)
LinkedIn is the undisputed leader in online professional contacts and recruiting. The company has the first-mover advantage in the business, and the network effect is a powerful source of self-sustaining competitive strength.
The company has 347 million registered users and 33,271 corporate solutions customers. Sales jumped 45% to $2.2 billion in 2014, so LinkedIn is clearly firing on all cylinders. Revenues will most likely outgrow expenses in the coming years, meaning profit margins should be on the rise. In this context, earnings should get a double boost from growing revenues and expanding margins.
That being said, LinkedIn is not a good fit for retirees. When investing in retirement, safety and stability are important considerations, since you do not want to be selling a stock at depressed levels to finance your income needs.
LinkedIn trades at a stratospheric valuation: The forward price-to-earnings ratio is around 60 times earnings forecasts for the coming year. The company has what it takes to grow into that valuation over time, but LinkedIn stock is still quite vulnerable to any disappointment in the short term.
Investing decisions are not just about differentiating between good and bad stocks -- the key is finding the right risk and reward equation to fit your own specific needs. LinkedIn is a great alternative for long-term investors looking for explosive growth opportunities but again not the best choice for retirees.
Andrés Cardenal owns shares of LinkedIn. Bob Ciura has no position in any stocks mentioned. Brian Stoffel owns shares of Baidu, Facebook, and LinkedIn. The Motley Fool recommends Baidu, Facebook, and LinkedIn. The Motley Fool owns shares of Baidu, Facebook, and LinkedIn. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.