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 Annaly Capital (NYS: NLY) 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 Annaly Capital.
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%
8 out of 10
Source: S&P Capital IQ. Total score = number of passes.
With eight points, Annaly Capital gives conservative investors just about everything they could ask for from a stock. The question, though, is whether the good times can last forever -- or whether the favorable conditions that have supported both Annaly's price and its dividend will eventually end.
For years now, Annaly and its mortgage REIT peers have benefited from low interest rates. Invesco Mortgage Capital (NYS: IVR) , Resource Capital (NYS: RSO) , and American Capital Agency (NAS: AGNC) now carry yields of more than 20%, and several other mortgage real estate investment trusts, including ARMOUR Residential (NYS: ARR) , have yields approaching that mark.
With Federal Reserve Chairman Ben Bernanke pledging to keep rates low until 2013, Annaly seems to have the wind at its back. But some investors fear that the good times may be coming to an end. The SEC is reportedly looking into changing the way that mortgage REITs do business, possibly limiting the use of leverage that produces so much of their returns. In addition, the Fed's new "Operation Twist" arguably hurts mortgage REITs by reducing yields on the long-term mortgage-backed securities that they buy.
Retirees and other conservative investors have to love the healthy income that Annaly provides, but the stock's recent volatility shows just how sensitive it is to both economic news and threats to its business model. Investors have to be prepared for the impact to earnings and the dividend that narrowing interest rate spreads will eventually bring, but for now, Annaly is enjoying an unprecedented set of circumstances in the economy that is serving its shareholders very well.
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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At the time thisarticle was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Annaly Capital Management. 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 a disclosure policy.
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