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 Costco (NAS: COST) 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 Costco.
What We Want to See
Pass or Fail?
Market cap > $10 billion
Revenue growth > 0% in at least four of five past years
Free cash flow growth > 0% in at least four of past five years
Beta < 0.9
Worst loss in past five years no greater than 20%
Normalized P/E < 18
Current yield > 2%
5-year dividend growth > 10%
Streak of dividend increases >= 10 years
Payout ratio < 75%
5 out of 10
Source: Capital IQ, a division of Standard & Poor's. Total score = number of passes.
With only five points, Costco isn't delivering everything that conservative investors want from their investments. The warehouse giant pioneered the big-box store concept, but the company now faces the retirement of its well-renowned CEO.
Costco has an amazing business model that resonates well with shoppers. The company collects a membership fee that gives shoppers access to Costco's deals, which reward bulk shopping and include attractive one-time deals. That combination has allowed Costco to hold up well against both mega-retailer Wal-Mart (NYS: WMT) and its Sam's Club warehouses as well as discounters like Target (NYS: TGT) and Big Lots (NYS: BIG) . That same business model is what has attracted private equity investors to smaller regional rival BJ's Wholesale (NYS: BJ) , which has also had better-than-expected results recently.
Costco is well-known for treating all of its stakeholders well, from employees and shoppers to investors. That has led not only to higher wages and benefits for its workers but also to dividend increases for shareholders.
Recently, though longtime CEO Jim Sinegal said that he would retire at the end of the year. Many are concerned about how any future CEO could step into his role, but Sinegal plans to advise the new candidate through 2012.
Retirees and other conservative investors may balk at fairly high valuations and a relatively low dividend yield. But if the company can find a good successor to Sinegal, then Costco still deserves a close look to see if it belongs in your retirement portfolio.
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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