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.
Ongoing concerns about sequestration and government budget cuts have plagued the entire defense industry and, as a smaller niche player in defense, L-3 Communications (LLL +0.00%) has been especially on edge. But, given its high-priority role in providing key technology, shareholders are hopeful that L-3 won't take too hard a hit. Below, we'll revisit how L-3 Communications does on our 10-point scale.
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.
- 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 these factors in mind, let's take a closer look at L-3 Communications.
|
Factor |
What We Want to See |
Actual |
Pass or Fail? |
|---|---|---|---|
|
Size |
Market cap > $10 billion |
$7.3 billion |
Fail |
|
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 |
2 years |
Fail | |
|
Stock stability |
Beta < 0.9 |
0.96 |
Fail |
|
Worst loss in past five years no greater than 20% |
(29.5%) |
Fail | |
|
Valuation |
Normalized P/E < 18 |
9.06 |
Pass |
|
Dividends |
Current yield > 2% |
2.5% |
Pass |
|
5-year dividend growth > 10% |
15.8% |
Pass | |
|
Streak of dividend increases >= 10 years |
9 years |
Fail | |
|
Payout ratio < 75% |
22.2% |
Pass | |
|
Total score |
5 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at L-3 Communications last year, the company has kept its five-point score. The stock, though, has managed to post a modest gain, rising about 10% over the past year.
L-3 isn't a huge company, but it provides some critical technology to the U.S. military. Along with electronic systems that include sensors for aircraft and fleet management services, L-3 provides security solutions for the Defense Department, as well as various intelligence agencies. Spun off from Lockheed Martin (LMT 3.08%) in 1997, L-3 has outperformed its former parent handily.
But fears of budget cuts have pushed valuations down for L-3 and its sector peers to extremely low levels. L-3, Northrop Grumman (NOC 2.08%), and General Dynamics (GD 1.73%) are all trading at less than 10 times forward earnings estimates and, given their reasonably solid profit-producing potential, such cheap valuations seem out of line and present a promising investment opportunity.
L-3 doesn't have clear sailing to dominance, though. Tech tycoon Peter Thiel, who founded PayPal, has a competing battlefield-data analysis product that goes up against the in-house DCGS program, which L-3 services alongside Northrop, Lockheed, and Raytheon (RTN +0.00%). If disruptive technology hits the military, L-3 will need to move forward to keep up.
For retirees and other conservative investors, L-3 combines good value with solid and growing dividends. For those willing to take the risk of defense cuts, L-3 is worth considering as an addition to 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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