Is Caterpillar the Right Stock to Retire With?

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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 Caterpillar (NYS: CAT) 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 Caterpillar.

Factor

What We Want to See

Actual

Pass or Fail?

SizeMarket cap > $10 billion$53.4 billionPass
ConsistencyRevenue growth > 0% in at least four of five past years3 yearsFail
 Free cash flow growth > 0% in at least four of past five years3 yearsFail
Stock stabilityBeta < 0.91.72Fail
 Worst loss in past five years no greater than 20%(36.8%)Fail
ValuationNormalized P/E < 1815.38Pass
DividendsCurrent yield > 2%2.2% Pass
 5-year dividend growth > 10%11.1%Pass
 Streak of dividend increases >= 10 years18 yearsPass
 Payout ratio < 75%28.1%Pass
    
 Total score 6 out of 10

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

With six points, Caterpillar gives conservative investors a lot of what they're looking for in a stock. The company has plenty of exposure to economic cycles, however, so concerns about what the future holds both for the U.S. and emerging markets like China will weigh heavily on the stock's prospects.

Caterpillar is among the world's top manufacturers of industrial equipment, which is used in industries ranging from mining and construction to power generation and trains. As a result, Caterpillar goes where the growth is, and lately, where that's been is the Asia/Pacific region.

Just five years ago, Caterpillar got more than half of its revenue from North America. Now, that figure is less than 40%, with Asia and Latin America combining to match its North American sales. In fact, Caterpillar has pressed its Asian exposure even further than competitors Deere (NYS: DE) and Terex (NYS: TEX) . Yet as Caterpillar has shifted its focus abroad, smaller competitors like Titan Machinery (NAS: TITN) have come in to take home sales away from the industrial giant.

For long-term investors, though, dividends have proven a key to their success with Caterpillar. Like fellow manufacturers Cummins (NYS: CMI) and Dover (NYS: DOV) , Caterpillar's dividends have almost tripled investor returns for those who reinvested payouts rather than taking them in cash. A healthy dividend growth rate and a long record of raising payouts regularly is exactly what retirees and conservative investors want from a stock.

Caterpillar sees a threat from the slowing global economy, especially with big potential headwinds coming from the U.S. debt downgrade and troubles in Europe. But Asia remains hot, and as long as that stays true, Caterpillar should continue to see good times.

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 Caterpillar 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 the13 Steps to Investing Foolishly.



At the time this article was published Fool contributorDan Caplingerdoesn't own shares of the companies mentioned in this article. You can follow him on Twitterhere. 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 adisclosure policy.

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