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3 Best Buys Now for your Roth IRA

Simon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There certainly is a lot of uncertainty in the market these days.

According to the American Institute of Individual Investors, only 29% of investors are bullish on the market, compared with 45% that are bearish.  The S&P and Dow are flirting with all-time highs and pundits are questioning if the market is set for a correction.  Shoot, even the Jersey Shore's Pauly D is offering investment advice these days.

Are they right?  Should we sell all of our stocks for cash and stuff it under our mattress? 

The short answer is no.  The majority of experts' short-term stock market predictions are wrong.  Investing should be a process for building wealth over the long term.  And a Roth IRA is an excellent tool for investors to use to help them reach their retirement goals. 

Contributions to a Roth IRA are funded with after-tax dollars and are allowed to grow tax-free.  Expenses paid to taxes normally dwarf those of transaction or maintenance fees, so tax-free growth is a huge advantage.

In addition to growing tax-free, there are additional ways that investors can maximize their returns from a Roth IRA.  Buying dividend-paying stocks and continually reinvesting those dividends into the plan is a strategy that can work very well for a Roth IRA.  Reinvesting dividends tax-free and transaction-free (*check with your broker) over long periods of time can create a compounding machine that will churn out some serious cash in the later years. 

When searching for stock candidates for your Roth IRA, there are a few important things to look for:

  1. The stock pays a dividend.  Jeremy Siegel famously quoted that dividends act as "bear-market protectors and return accelerators".  When holding over a long period of time, reinvesting dividend income will help you ride out the rough times in the market.
  2. The stock is increasing its dividend.  One of the biggest advantages that stocks have over bonds is the ability to boost their payments in the future.  Some companies, such as the S&P Dividend Aristocrats, have increased their dividends for extremely long periods of time.  We want stocks that have a history of dividend increases and also the funds available to continue to increase them into the future.
  3. The stock is attractively valued.  As I have said before, buying at the right price is the single most-important factor that we can control as investors to impact our returns.  We should be on the lookout for stocks whose prices are lagging their underlying fundamentals. 

There are a few metrics that can help to show if a stock is hitting the above-mentioned criteria. 

  • A stock's Dividend Yield will show if it is currently paying a dividend. 
  • The 4-Year Dividend Increase will display the total increase in the dividend payout since 2007.  Bigger is better.
  • The Free Cash Flow Payout will show the amount of cash that the company is paying out as a dividend as compared to how much it is bringing in.  We want to find low payout ratios.  Companies paying dividends should have plenty of incoming cash available for them to continue to increase their dividends. 
  • A low Forward P/E Ratio represents stocks that are selling 'cheaply' on the market. 
  • Finally, the FCF Yield represents the free cash coming into the company divided by the stock price.  Just like the dividend yield, bigger is better

Now, with all of the inputs established, we can move on to the good part.  The following three stocks appear to be ideal candidates for consideration for a Roth IRA:

<table> <tbody> <tr> <td> </td> <td><span>RecentPrice</span></td> <td><span>Mkt Cap ($MM)</span></td> <td><span>Fwd P/E</span></td> <td><span>Div Yield</span></td> <td><span>4 Yr Div Incr</span></td> <td><span>FCF Yield</span></td> <td><span>FCF Payout</span></td> </tr> <tr> <td><span>BLK</span></td> <td><span> $         189.64 </span></td> <td><span> $                 32,808 </span></td> <td><span>14.4</span></td> <td><span>3.2%</span></td> <td><span>123%</span></td> <td><span>7.9%</span></td> <td><span>40%</span></td> </tr> <tr> <td><span>HI</span></td> <td><span> $           20.89 </span></td> <td><span> $                   1,308 </span></td> <td><span>12.4</span></td> <td><span>3.7%</span></td> <td><span>38%</span></td> <td><span>12.8%</span></td> <td><span>29%</span></td> </tr> <tr> <td><span>INTC</span></td> <td><span> $           21.52 </span></td> <td><span> $               107,575 </span></td> <td><span>9.7</span></td> <td><span>4.2%</span></td> <td><span>74%</span></td> <td><span>9.5%</span></td> <td><span>44%</span></td> </tr> </tbody> </table>

Forward EPS derived by taking consensus estimates for 2012 earnings.  Sources:  S&P Capital IQ and Morningstar.com.  Prices are as of October 19, 2012.

BlackRock (NYSE: BLK) is the world's largest asset manager, with $3.5 trillion of client assets invested in both fixed-income and equities.  Barron's recently sang a bullish tune about BlackRock, saying that shares were significantly undervalued.  The company is aggressively increasing its dividend and should continue to see earnings rise alongside the yields of bonds.  At a FCF Yield of 8% and a FCF payout of only 40%, BlackRock's dividend and stock price both have plenty of room to run.

Hillenbrand (NYSE: HI) is America's leading death-care provider (yes, you read that correctly).  They are the top-dog in an important and stable industry, and they are using those stable cash flows to expand into material handling equipment.  Hillenbrand just completed a sizeable acquisition of German-based Coperion Capital, which will add about $1 billion to their top-line.  Coperion should fit nicely into their industrial products core competency and should integrate well.  With a FCF Yield of 13% and a dividend of nearly 4%, the market isn't giving Hillenbrand enough credit.

Intel (NASDAQ: INTC) is a stock that deserves a place in any retirement portfolio.  Near-term fears about "The Death of the PC" have offered an opportunity for investors to buy a best-in-class company with a wide competitive advantage for an incredible price.  Intel looks extremely cheap, with a forward P/E below 10 and a FCF Yield approaching 10%.  Expect Intel to leverage its massive R&D budget to break into smartphones and to continue to benefit from data centers being built to support the cloud.  Long-term investors will be rewarded.

Foolish Bottom Line

Time is the ally of the individual investor.  We don't have short-term performance targets or industry benchmarks to stress us out or encourage foolish (small 'f') behavior.  Seeking out great companies that pay continually-rising dividends is a recipe for success.  Compounding those dividends for long periods of time through a tax-free Roth IRA could help you to achieve the retirement of your dreams. 

TXinvestor82 owns shares of Intel in a Roth IRA.  The Motley Fool owns shares of Hillenbrand and Intel. Motley Fool newsletter services recommend Hillenbrand and Intel. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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