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.
In the race for portfolio income, dividend-paying stocks have gotten huge amounts of attention lately. Near the top of the yield charts is Annaly Capital (NYS: NLY) , thanks to its status as a real estate investment trust making leveraged investments on mortgage-backed securities. With the Fed's low interest rate policy, Annaly has seen huge success in the past several years. But now that quantitative easing has focused directly on mortgage securities, have mortgage REITs seen their best times come and go? Let's revisit how Annaly Capital 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 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%
5 out of 10
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at Annaly Capital last year, the company has lost three points. Yet even after a recent decline, the shares have posted a small gain, and Annaly's dividends have brought its total return into double-digit percentages.
Mortgage REITs like Annaly have been dividend dynamos in recent years. By borrowing at cheap short-term rates and taking advantage of a relatively steep yield curve to buy longer-maturity mortgage debt, Annaly and its peers have generated huge amounts of income.
But recently, those trends have started changing, as a flattening yield curve and increased demand for mortgage-backed securities in particular has squeezed margins. That in turn has put pressure on dividends, with American Capital Agency (NAS: AGNC) , Hatteras Financial (NYS: HTS) , and Anworth Mortgage Asset (NYS: ANH) all joining Annaly in making dividend cuts over the past year. REITs focusing on non-agency debt haven't been spared either, with Chimera (NYS: CIM) making two dividend cuts in the past four quarters.
Just this week, Annaly released its market commentary for the most recent quarter. In it, Annaly notes that the Federal Reserve's QE3 program will have marked effects on the mortgage securities market, with lower rates, tighter spreads, and higher prepayment expectations all potentially weighing on the business.
For retirees and other conservative investors, Annaly remains an attractive but dangerous stock. Despite its relative calmness in recent years, rising interest rates have sent shares down in the past and could do so again. Yet even with a smaller dividend, the stock's yield would remain attractive. Investors need to be comfortable with the risks in order to make Annaly part of their 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.
A short article can't tell you everything you need to know about Annaly Capital. Get the whole scoop on Annaly's business model by reading our new premium research report on the company, in which our analyst runs through whether Annaly is a buy as well as the future opportunities and pitfalls the mortgage REIT faces. Click here now to claim your copy.
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The article Will Annaly Capital Help You Retire Rich? originally appeared on Fool.com.
Fool contributor Dan Caplinger has no positions in the stocks mentioned above. The Motley Fool owns shares of Annaly Capital. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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