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, then examine whether Paychex (Nasdaq: PAYX) has what we're looking for.

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 Paychex.


What We Want to See


Pass or Fail?

Size Market cap > $10 billion $11.4 billion Pass
Consistency Revenue growth > 0% in at least four of five past years 4 years Pass
  Free cash flow growth > 0% in at least four of past five years 3 years Fail
Stock stability Beta < 0.9 0.85 Pass
  Worst loss in past five years no greater than 20% (24.6%) Fail
Valuation Normalized P/E < 18 23.36 Fail
Dividends Current yield > 2% 3.9% Pass
  5-year dividend growth > 10% 16.4% Pass
  Streak of dividend increases >= 10 years 0 years Fail
  Payout ratio < 75% 87.6% Fail
  Total score   5 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

With just five points, Paychex doesn't give conservative investors everything they'd like to see in a stock. Yet even with a dividend payout ratio that raises some concerns about sustainability, Paychex provides good income for shareholders, and it's been relatively consistent in its growth.

Paychex competes with archrival ADP (Nasdaq: ADP) in the payroll processing services business. Under ordinary circumstances, Paychex gets paid twice for its trouble: once by businesses paying for its services, and another time through interest on the float between when it collects payroll money from employers and when it actually pays that money out. Unfortunately, with interest rates at current low levels, interest income has effectively dried up, which is partially responsible for the company's free cash flow contraction over the past two years.

Paychex attracts smaller employers than ADP, with 82% of clients having fewer than 20 employees. That has left it more exposed to the economic recession, as small businesses have taken a harder hit and are quicker to drop external services than big employers. But it still pays a higher dividend yield than ADP, Hewitt Associates acquirer Aon (NYSE: AON), and smaller competitor Insperity (NYSE: NSP), and has sported faster dividend growth than ADP and Insperity over the past five years as well.

Paychex's numbers aren't unanimously optimistic, and with doubts about the strength of the recovery, the company is vulnerable to a double-dip. But with a strong dividend and opportunities for long-term growth, retirees and other conservative investors may nevertheless want to keep an eye on Paychex.

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.

Add Paychex to My Watchlist , which will aggregate our Foolish analysis on it and all your other stocks.

If you want to retire rich, you need to be confident that you've got the basics of your investment strategy down pat. See if you're on track by following the 13 Steps to Investing Foolishly.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of Aon. Motley Fool newsletter services have recommended buying shares of Paychex and ADP. 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.