Recently, I've been writing a lot about why I believe the future is bleak for bonds. It occurred to me that this information might be most material to the older demographic: that is, retirees or those nearing retirement age. After all, what's the first adage everyone hears about portfolio balancing?
Your age in bonds, 100% minus your age in stocks.
While this advice may well have served past generations, it's not great advice today. As I've discussed in previous articles (see: Why Buffett Hates Bonds and Future Bleak For Treasury Bonds), bonds are a bad investment right now. The pitifully low yields aren't even enough to keep the forces of inflation and taxation at bay.
The obvious solution is to buy more equities, for reasons I outlined in Hook 'em Horns: The Bullish Long Term Case for US Stocks. Unfortunately, one of the things I established in that article is that in the near term (next few years), Europe may continue to mess things up. While this situation presents awesome buying opportunities for younger investors, those nearing retirement don't have the time to wait 10, 5, or in some cases even 3 years. If you need money now, you may be tempted to start taking larger bites out of your capital. After all, the old "time-tested" strategy of transferring to bonds and living off the yield... well, let's just say it isn't working out.
So you're left with only one viable option: buying stocks. But how to do it? Investing in mutual funds is theoretically a surefire way to make money on the market, but the cautionary tale of the Magellan Fund suggests that even the most prestigious funds aren't infallible.
Index investing in an ETF like the DIA, SPY, or QQQ is another commonly suggested strategy, but again, a look at the charts shows that investors in index funds like SPY are still holding a loss if they bought in 5 years ago.
SPY data by YCharts
So as it turns out, the only real way to be in complete control of your portfolio is to do it yourself. While this may be scary, you have a lot of tools at your disposal.
Your broker probably has a "stock screener" on their website, which can be used to find stocks based on characteristics. A lot of my articles are based on such stock screeners -- by utilizing financial metrics like P/E ratios and PEG ratios and TTM EPS growth, it's pretty easy to sort out the good companies from the bad ones. But again, my timeframe is a lot longer than that of most older Americans. I can afford to buy Bank of America (NYSE:BAC) and sit on it for 10 years in hopes of achieving a phenomenal return down the road. Most people nearing retirement need more of a sure thing in a nearer time frame.
So what I did is went on the Fidelity website and set up a fairly comprehensive stock screen to narrow down the entire market to stocks that (I think) are suitable for retirees. Instead of just giving the results, I'm going to go through my thought process in setting up the screen, because I'm a big advocate of the "buy a man a fish, feed him for a day, teach a man to fish, feed him for a lifetime" mentality.
Below is a picture of what my completed stock screen looks like. Looking at the setup will give you an idea of how to set up a stock screen -- basically, you can select whatever criteria you want. Your broker's interface may be slightly different from Fidelity's, but should be close enough. I'll explain each step in detail and examine why each specific criterion is important for retirees or near-retirees.
My first criterion is fairly simple: I selected the security type of common stock. This excludes investments such as REITs from the screen.
My second criterion is Market Cap > $2 billion. This limits the results to large-cap "blue chip" stocks. While there's no universal law stating that large caps can't go belly up (or that mid caps and small caps are dangerous), large caps typically tend to be the more "staid" sort of investments that defensive investors like retirees can rely on for part of their core portfolio.
My third criterion is Security Price between $5 and $100. This is to ensure that only stocks with reasonable valuations appear -- you don't want penny stocks, obviously, but stocks with extremely expensive valuations can be difficult to deal with. Why? Well, if you have a $700 stock, and you can only afford to invest $3500 in that specific stock, you don't have a lot of control over adding or subtracting small positions over time.
My fourth criterion is Dividend Yield greater than or equal to 3%. This ensures that investors will receive a steady stream of income in retirement, as they would under the traditional bond-investing strategy. Assuming a $200,000 retirement portfolio, a dividend yield of 3% works out to $6,000 of income a year without having to touch your invested capital at all. A $500,000 portfolio will generate $15,000 in income, and so on and so forth.
My fifth criterion is 5-yr average dividend growth rate greater than or equal to 5%. What does this mean? It means that the company in question has raised its dividend by an average of 5% or more per year over the last five years. This does two things: first, it means you'll be receiving an increasing "yield-on-cost" in the future. (Your cost basis stays the same, but the dividend grows.) Second, it means that the company continued to pay and in fact increase the dividend even through the financial crisis of 2008 -- an indicator that the company is well managed and continues to take care of shareholders even in the worst of times.
My sixth criterion is 5-year historical EPS growth greater than or equal to 0%. Investors in or nearing retirement aren't looking to hit home runs, but it's definitely important to be investing in a company that's showing some expansion -- not contraction. (Nobody likes a contracting company.)
My seventh criterion is 5-yr Historical Cash Flow Growth Rate greater than 0%. Becausing of accounting maneuvers, "earnings" can sometimes be impacted by depreciation, amortization, and other such things. Cash flow is an indicator that can be used to verify that earnings are indeed growing due to good business -- not just due to accounting tricks.
My eighth criterion is forward EPS growth greater than 0%. Same logic as the sixth. If the company continues to grow, share prices should remain stable or increase.
My ninth criterion is P/E less than or equal to 20. Price-to-earnings is a measure of how much each share costs in terms of earnings -- that is, a stock with a P/E of 20 costs the same amount as 20 years of earnings per share. The market average P/E is about 15.7 right now, and too high of a P/E means that the company's shares could be overvalued. Capping the P/E at 20 allows investors to know they're not drastically overpaying for the company in comparison to the market as a whole.
My tenth criterion is Beta is in the 60th percentile or below. Beta is a measure of a stock's volatility -- high beta stocks tend to be far more volatile. Volatility is obviously not something older investors really want, so setting Beta to 60th percentile or below ensures that only stocks with average or below-average volatility will show up.
My eleventh and final criterion is total return (5 year annualized) greater than or equal to 3%. This ensures that the stock actually performed well over the past 5 years -- again, a sign of good management through the financial crisis and economic downturn. This is an important consideration for retirement portfolios, because a dividend's no good if your investment is worth half of what it was before the crash. (It's worth noting that the "market median" for total return over the past five years is -6.70%. That's a negative sign in front of the 6. So the stocks we're left with are good performers compared to the market as a whole.)
Now that the screen is complete, our stocks show up. There are nineteen. They are:
CMS Energy Corp (NYSE:CMS)
Hasbro Inc (NASDAQ:HAS)
National Bank of Canada (OTCPK:NTIOF)
Darden Restaurants Inc (NYSE:DRI)
McDonald's Corp (NYSE:MCD)
Toronto-Dominion Bank (NYSE:TD)
Cleco Corp (NYSE:CNL)
Mattel Inc (NASDAQ:MAT)
Telus Corp (NYSE:TU)
Northeast Utilities (NU)
Sempra Energy (NYSE:SRE)
Abbott Laboratories (NYSE:ABT)
Reynolds American (NYSE:RAI)
General Mills (NYSE:GIS)
Wisconsin Energy Corp (NYSE:WEC)
Nextera Energy Inc (NYSE:NEE)
Genuine Parts Co (NYSE:GPC)
Heinz Co (NYSE:HNZ)
Kimberly Clark Corp (NYSE:KMB)
PepsiCo Inc (NYSE:PEP)
Most of the stocks above look pretty good (that McDonald's one definitely sounds familiar), with the exception of National Bank of Canada, which is OTC and therefore not really very obtainable for the average investor. There's no such thing as a "sure thing" in investing, but this list seems to be as close as it comes -- they've weathered the financial crisis pretty well in terms of dividends and earnings growth, and they're not terribly overvalued. An equally-weighted portfolio of these stocks would've provided a good return and solid income even through the downturn. Consequently, they could form the core of a retirement portfolio.
There are a couple of things I'd like to mention. First, the idea of "score weighting." Fidelity has a feature (and your broker should as well) where individual components can be weighted. For example, if high dividends and dividend growth are most important to you, you could weight those criteria higher so that those stocks receive a higher "score."
The second interesting observation is that many "blue chips" I would've expected to appear [think Coca Cola (NYSE:KO), Procter & Gamble (NYSE:PG), Johnson and Johnson (NYSE:JNJ)] didn't appear on the screen. These are obviously defensive dividend-paying stocks that are potentially suitable for retirement investors. I'll have to analyze these stocks and figure out what criterion knocked them out of contention -- a topic for another article, perhaps.
To conclude, it's obviously necessary to do more than just run a stock screen then hit the "buy" button. However, a rigorous stock screen that analyzes stocks from all angles can be a great starting point for building your own diversified portfolio. I believe my criteria are appropriate, but they're by no means the end-all be-all solution to investing -- I encourage you to consider your own needs and tweak some of my criteria to suit your financial plan. Perhaps you'd like a higher dividend yield, but you're okay with investing in mid cap stocks -- in which case, criteria 4 and 2 could be modified. Or maybe you're still a few years away from retirement, and you're willing to sacrifice immediate dividend yield for capital appreciation. In that case, you could ratchet up the "total return" requirement and pull back a little on the "dividend yield" requirement.
In any case, the Internet is the great equalizer. The widespread availability of information -- and access to tools like stock screeners -- means that you no longer have to rely on investing in an index or your brokerage's mutual funds. Those are fine strategies, of course (I personally hold several mutual funds and index ETFs), but with a little effort and guts, you can empower yourself to make your own decisions and customize your investing strategy to meet your unique needs.
Please let me know in the comments section if you found this article to be helpful, and feel free to add any feedback you may have. What criteria would you use to build your own personalized stock screen?
Disclaimer: I am an individual investor, not a licensed investment advisor or broker dealer. Investors are cautioned to perform their own due diligence. All information contained within this report is presented as-is and has been derived from public sources & management. Always contact a financial professional before making any major financial decisions. All investments have an inherent degree of risk. The future is uncertain, and actual results may be materially different from those expected. Past performance is no guarantee of future results. All views expressed herein are my own, and cannot be interpreted as the views of my employer(s) or any organizations I am affiliated with. Presentation of information does not necessarily constitute a recommendation to buy or sell. Never make any investment without conducting your own research and reading multiple points of view.
Disclosure: Long BAC