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. Let's figure out what makes a great retirement-oriented stock and then examine whether Automatic Data Processing (Nasdaq: ADP) has what we're looking for.
The right stocks for retirees
If you have decades to go before you need to tap your investments, you can take greater risks and weigh 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. Although many investors look for rapidly 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 can suddenly torpedo a stock's share price.
- Stock stability. Conservative retirement investors prefer investments that move less dramatically than typical stocks do, 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 quickly during bear markets. Beta measures volatility, but we 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 and gives 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 the dividend doesn't jeopardize the company's financial health.
With those factors in mind, let's take a closer look at Automatic Data Processing.
|
Factor |
What We Want to See |
Actual |
Pass or Fail? |
|---|---|---|---|
| Size | Market cap > $10 billion | $25.7 billion | Pass |
| Consistency | Revenue growth > 0% in at least four of the five past years | 3 years | Fail |
| Free cash flow growth > 0% in at least four of the past five years | 3 years | Fail | |
| Stock stability | Beta < 0.9 | 0.63 | Pass |
| Worst loss in the past five years no greater than 20% | (9.1%) | Pass | |
| Valuation | Normalized P/E < 18 | 22.39 | Fail |
| Dividends | Current yield > 2% | 2.8% | Pass |
| 5-year dividend growth > 10% | 16.3% | Pass | |
| Streak of dividend increases >= 10 years | 36 years | Pass | |
| Payout ratio < 75% | 56.5% | Pass | |
| Total score | 7 out of 10 |
Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.
With a score of 7, Automatic Data Processing has a lot to offer conservative investors. The business-services giant has had to roll with the punches that the economy has dealt it lately, but a solid history of rising dividends has helped its shares from feeling the full brunt of the recession.
Along with archrival Paychex (Nasdaq: PAYX), ADP is primarily in the business of processing payrolls for businesses. That can be a lucrative niche, as it enables ADP not just to profit from what it charges for its services but also to earn interest on money it holds on behalf of its corporate clients.
But because it serves other businesses, ADP is also sensitive to the overall economy. Just as outsourcing companies such as Insperity (NYSE: NSP) and Robert Half International (NSE: RHI) rely on hiring demand to support their outsourcing businesses, employers who are laying people off don't need ADP's payroll-management services as much.
Yet ADP tends to go after bigger companies than Paychex does. That approach leaves ADP with slower growth prospects but also offers less exposure to economic swings than if it focused on small businesses. In addition, ADP has started to move into emerging markets such as Brazil, India, and China.
In recent years, ADP has seen revenue and free cash flow growth sputter during economic downturns, but investors now recognize it as a defensive play with opportunities for long-term growth. Its shares are more expensive than conservative investors like to see, but it still deserves a close look to see whether it belongs in your retirement portfolio.
Keep searching
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.
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