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.
Heavy machinery needs powerful engines to run, and more than ever, people need reliable power generators for a variety of uses. Cummins (NYS: CMI) is one of the top companies providing those things, using an independent business model to serve other businesses with the components they need. But if the global economy starts slowing down, does Cummins have what it takes to keep on truckin'? Below, we'll look at how the company 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 Cummins.
What We Want to See
Pass or Fail?
|Size||Market cap > $10 billion||$16.9 billion||Pass|
|Consistency||Revenue growth > 0% in at least four of five past years||4 years||Pass|
|Free cash flow growth > 0% in at least four of past five years||4 years||Pass|
|Stock stability||Beta < 0.9||1.99||Fail|
|Worst loss in past five years no greater than 20%||(57.4%)||Fail|
|Valuation||Normalized P/E < 18||11.32||Pass|
|Dividends||Current yield > 2%||1.8%||Fail|
|5-year dividend growth > 10%||30.4%||Pass|
|Streak of dividend increases >= 10 years||6 years||Fail|
|Payout ratio < 75%||13.8%||Pass|
|Total score||6 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
With six points, Cummins has some -- though not all -- of the attractive traits conservative investors like. In particular, Cummins has had strong dividend growth recently, and its low payout ratio gives the company room for those increases to continue.
Cummins has plenty of competition in making engines, with Navistar (NYS: NAV) and Caterpillar (NYS: CAT) also capitalizing on strong demand for machinery. But instead of having a vertically integrated business model that includes fully built vehicles that incorporate its engines, Cummins instead chooses to sell its products to customers such as Ford (NYS: F) and PACCAR (NAS: PCAR) . That strategy has worked well, with revenues up -- especially in fast-growing emerging markets.
That independence has paid some big dividends. For instance, Cummins has long had a partnership with Westport Innovations (NAS: WPRT) , which has vaulted into the spotlight recently with its plans to make natural-gas-powered engines a more viable alternative for commercial purposes. Having already cut the effective cost of a diesel-to-gas conversion in half, Cummins and Westport could reap big dividends going forward.
For retirees and other conservative investors, it's those dividends that are of paramount concern. Cummins stock is more volatile than you'd like to see and is prone to the downturns of the overall economy. But the company has shown an ability to keep raising payouts even in tough times -- something few other industrial companies can say. At current cheap valuations, Cummins is worth a look for more risk-tolerant retirement portfolios.
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 this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of Ford, PACCAR, Cummins, and Westport Innovations. 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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