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.
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:
1). 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.
2). 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.
3). 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.
4). 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.
5). 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 IBM.
| Factor | What We Want to See | Actual | Pass or Fail? |
|---|---|---|---|
| Size | Market cap > $10 billion | $228 billion | Pass |
| Consistency | Revenue growth > 0% in at least four of five past years | 3 years | Fail |
| Free-cash-flow growth > 0% in at least four of past five years | 3 years | Fail | |
| Stock stability | Beta < 0.9 | 0.68 | Pass |
| Worst loss in past five years no greater than 20% | (20.8%) | Fail | |
| Valuation | Normalized P/E < 18 | 17.02 | Pass |
| Dividends | Current yield > 2% | 1.7% | Fail |
| 5-year dividend growth > 10% | 17.1% | Pass | |
| Streak of dividend increases >= 10 years | 17 years | Pass | |
| Payout ratio < 75% | 22.9% | Pass | |
| Total score | 6 out of 10 |
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at IBM last year, the company has dropped two points, having seen revenue and free cash flow drop over the past year. The stock has also been stuck in the doldrums, rising by less than 5% over the past year.
IBM has done an excellent job of anticipating the need to transform itself from a commodity consumer hardware business to a diversified technology-services company, beating most of its former hardware rivals into more promising areas. But even though IBM has been able to keep raising profits, revenue has slowed down, pointing to long-term concerns for the company.
In response, IBM is looking at several key tech trends. The big data concept is one of the keys to the company’s future, as IBM tries to bring not only raw data but also analysis to the deluge of information available via smart mobile devices, making those devices more useful and essential going forward. In addition, the company will challenge Amazon.com, Inc. (NASDAQ:AMZN) , as well as smaller players, in attacking the cloud-computing space: IBM is looking to focus not just on the biggest enterprises, but also on mid-sized businesses that have previously gone underserved.
But IBM isn’t the only company doing so. Many believe that Oracle Corporation (NASDAQ:ORCL)‘s recent purchase of Acme Packet was an attack on networking rival Cisco Systems, Inc. (NASDAQ:CSCO) . But both Oracle and Cisco have been trying to achieve the same ends as IBM: broadening their offerings beyond their respective strengths to offer complete technology solutions to their customers without relying on outside third parties.
For retirees and other conservative investors, IBM’s dividend yield has always been below where it could be, given the company’s greater emphasis on share buybacks to bolster EPS toward its long-term target of $20 per share by 2015. With the stock near full valuation, you may prefer to wait for a pullback before deciding to add IBM to your retirement portfolio.
The article Will IBM Help You Retire Rich? originally appeared on Fool.com and is written by Dan Caplinger.
Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Cisco Systems. The Motley Fool owns shares of Amazon.com, IBM, and Oracle.
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