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Should Retirees Buy Stocks (Part 2)

|Includes:The Travelers Companies, Inc. (TRV)

First read "Should #Retirees Buy Stocks (part 1)".

Retirees typically invest in low returning investment choices based on the advice of their financial planner, or simply because they may perceive bonds and guaranteed/certified deposit accounts as more safe and secure.

They often invest in these investment vehicles while unfortunately watching the value of their investment portfolios decline faster than their life expectancy. The question begs… where will seniors be able to derive more income from their investments, while at the same time, mitigate the risk of investment losses?

I suppose, if the question were "should I buy stocks", the underlying question becomes "how do I choose a stock to invest in?"

For the purposes of this summary, I've elected to use Travelers ($TRV) as an example of a Dow stock that may be suitable for inclusion in a retiree's portfolio.

At a high level, and without getting overly technical, retirees can consider these 5 factors when deciding whether to invest:

  1. Size: Ideally, there is safety in relative size and retirees should not be taking chances with new or unproven businesses. TRV is a Dow-Index listed company with a 150-year history as a leading U.S. insurance corporation. The corporation has a market value (or capitalization) of about $31.6 billion, and employs more than 30,000 employees. While large companies may not grow as fast as small companies, large companies offer far greater security than new 'upstarts'.
  2. Dividends: Retirees would generally want to earn income via dividends. In addition to healthy payouts now, they should also look for dividend growth over time. TRV offers a current dividend yield of 2.2% (vs. an industry average of 1.23%), a 5-year dividend growth of nearly 10% and 8 consecutive years of dividend increases. Not the greatest, but very good.
  3. Valuation: For publicly traded corporations, we typically look for a 'normalized' Price/Earnings ratio (P/E = the share price divided by the earnings per share) of <18. On March 22, 2013 TRV's P/E was 13.32
  4. Stock Stability: This may be a little too technical, but it's worth sharing anyway for those who are interested. To measure stability, we determine beta, defined as the measure of the risk or volatility of TRV vs. the market as a whole. Financial advisors may be looking for a beta of less than 1. A beta of 1 indicates that the security's price will move with the market. Less than 1 means that the security will be less volatile than the market. And greater than 1 indicates that the security's price will be more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market. Currently, TRV offers a beta = 0.67, meaning that TRV is less volatile than the market as a whole. In addition, investors don't like stocks that have experienced losses of greater then e.g. 20% at any time, during the past five years. TRV lost 5.9% in 2008/9 when the stock market 'crashed', faring far better than most other companies.
  5. Consistency: Here we should look at revenue growth - after all, we don't want to invest in a declining company - and specifically at the revenue growth over a period, e.g. 5 years. TRV has generated positive revenue growth for the last 4, and this is acceptable. Another way to analyze consistency would be to explore TRV's free cash flow growth, once again looking for positive growth over a period of e.g. 5 years. TRV has only managed growth in free cash flow for 2 of the past five years, but as an insurance company, TRV took some heavy body blows as a result of natural disasters, like hurricanes Irene and Sandy. Not the greatest in generating free cash flow growth, but respectable. Losses were more as a result of uncontrollable business events caused by natural disasters (the large insurance payouts), than poor management decisions.

An analysis like the one above is meant to provide highlights of company performance to assist small investors with investment decisions. Your financial advisor would obviously be more in tune with your unique, personal financial situation and investment return requirements.

As I write this article, the Dow has returned just more than 10% YTD (March 22, 2013). This performance is slightly better than the historical performance, generating around 7% annually, for the past 100 years.

If you - as a retiree - have most of your wealth invested in a portfolio of relatively poor performing, 'low risk' investment vehicles, speak to your wealth manager to discuss your investment returns achieved. Ensure that you are not invested in a real declining asset portfolio, especially when adjusted for annual inflation!

Stocks: TRV