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.
During the 1990s, Microsoft (MSFT 1.57%) put thousands of workers in position to retire at will, with a massive run-up in its stock that made millionaires out of even some rank-and-file employees. But lately, Microsoft has been stuck in a mature-company rut. Can the company reignite its growth engine once more? Let's revisit how Microsoft 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 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 Microsoft.
|
Factor |
What We Want to See |
Actual |
Pass or Fail? |
|---|---|---|---|
|
Size |
Market cap > $10 billion |
$231 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 |
0.97 |
Fail |
|
Worst loss in past five years no greater than 20% |
(44.4%) |
Fail | |
|
Valuation |
Normalized P/E < 18 |
14.44 |
Pass |
|
Dividends |
Current yield > 2% |
3.3% |
Pass |
|
5-year dividend growth > 10% |
15.4% |
Pass | |
|
Streak of dividend increases >= 10 years |
10 years* |
Pass | |
|
Payout ratio < 75% |
45.1% |
Pass | |
|
Total score |
8 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
*Based on fiscal years.
Since we looked at Microsoft last year, the company has picked up a point, thanks to counting its fiscal-year dividend increases. The shares, however, haven't done nearly as well, dropping about 10% over the past year.
Microsoft has thrived over the years as a result of its cash-cow operating system and office software, each of which brings in more than a quarter of the company's overall revenue and together account for all of its profits. Yet with the decline of the PC in favor of mobile devices, investors worry that Microsoft's days of dominance may be numbered if it can't adapt to changing technology trends, as Apple (AAPL 2.15%) and Google (GOOG 0.42%) have captured huge portions of the mobile OS market as a result of their iOS and Android offerings, which now lead the smartphone market.
As a result, investors have looked closely at the recent release of the more mobile-friendly Windows 8 operating system and the Surface tablet. The original Surface got off to a slow start, but with the Surface Pro version having become available over the weekend to strong demand, Microsoft finally offers a full-blown tablet capable of running PC-style applications. The tablet may also boost Intel's (INTC +1.14%) mobile fortunes, as the Pro uses an Intel i5 processor, although short battery life concerns for the Surface Pro may raise questions about Intel's capacity to provide power-friendly mobile processors.
As for Windows 8, it hasn't been nearly the success that Microsoft had hoped. The operating system failed to bail out ailing PC manufacturers, and even though Microsoft said in mid-January that it had sold 60 million Windows 8 licenses, many of those were discounted upgrades that won't necessarily produce huge amounts of revenue.
For retirees and other conservative investors, none of this arguably matters. So far, the Windows and business software divisions have managed to grow both sales and profits despite adverse trends away from PCs, producing huge amounts of cash that have led to higher dividends. With shares trading at a very reasonable valuation, Microsoft doesn't need to be a big grower to give investors good value at current prices.
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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