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.
As the king of fast food, McDonald's
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 McDonald's.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$102 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||4 years||Pass|
|Stock stability||Beta < 0.9||0.45||Pass|
|Worst loss in past five years no greater than 20%||4%*||Pass|
|Valuation||Normalized P/E < 18||21.02||Fail|
|Dividends||Current yield > 2%||2.8%||Pass|
|5-year dividend growth > 10%||20.4%||Pass|
|Streak of dividend increases >= 10 years||35 years||Pass|
|Payout ratio < 75%||47.3%||Pass|
|Total score||9 out of 10|
Source: S&P Capital IQ. Total score = number of passes. *This figure is a gain; McDonald's has not suffered a loss in the past five years.
Since we looked at McDonald's last year, the company has kept its nine-point score. With another strong performance for the stock in 2011, the fast-food chain has actually seen its valuation increase compared to last year's figures.
McDonald's has been fighting a two-front war. On one hand, it has aggressively expanded into the domestic coffee market, going up against Starbucks
At the same time, the company believes that it needs to get better coverage in emerging markets. Doing so would counter Yum! Brands
But some think McDonald's has gotten ahead of itself. As Fool contributor Morgan Housel points out, McDonald's stock has doubled in price in the past two and a half years, and remember: It didn't drop during 2008's bear market either. Despite further growth opportunities, it's uncertain whether that growth can come fast enough to justify the stock's current valuation. Moreover, as the economy improves, casual-dining alternatives will become more of a challenge to overcome. Just this week, Buffalo Wild Wings
For retirees and other conservative investors, paying a little too much for such a strong stock may be worth the risk. With a quickly growing dividend that always pays a handsome yield, McDonald's has everything you could want for a retirement portfolio. If the share price ever pulls back, it would be the perfect time to buy.
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. The Motley Fool owns shares of Starbucks, Yum! Brands, and Buffalo Wild Wings. Motley Fool newsletter services have recommended buying shares of Yum! Brands, McDonald's, Buffalo Wild Wings, and Starbucks, as well as writing covered calls on Buffalo Wild Wings. 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.