Smoking Hot Dividends
Arthur is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
What’s good for one’s portfolio isn’t always the same thing that’s good for one’s health. The detrimental effects of smoking are well documented and well understood by smokers and non smokers. Yet, the habit continues to be prevalent, although more taboo perhaps than 30 years ago. While several government bodies have identified a trend in which the number of cigarette smokers is falling, those who do smoke tend to smoke more often. With a steady number of smokers and increasing cigarette prices, tobacco companies are continuing to prosper.
Over the last 5 years, major cigarette manufacturers have produced stellar returns, beating the market by a wide margin. Altria Group (NYSE: MO), Reynolds America (NYSE: RAI), Lorillard (NYSE: LO) and Phillip Morris (NYSE: PM) shares increased by 30%, 34%, 43% and 47% within this time period. While the cigarette companies are up an average of 39%, the S&P has fallen by nearly 4% during that timeframe.
The discrepancy between returns produced by cigarette companies and the broader market becomes even more apparent when dividend income is factored in. Altria and Reynolds lead the way as the top yielders in this group, supporting dividend yields of 5.78% and 5.66%, respectively. Lorillard pays out only 4.74% and Phillip Morris is at the bottom of the list with 4.11%. In contrast, the average company in the S&P carries a yield under 2.1%. After considering dividends, the 43% discrepancy between cigarette makers and the market over a 5-year time horizon would be more to the order of 70%, assuming that dividends are reinvested.
The negative stigma associated with cigarette stocks and the ongoing concern over legal issues continues to push the industry to trade at discounts to the overall market, ignoring the stellar returns produced by the companies. In terms of valuation metrics such as the often used P/E and P/S ratios cigarette companies are not fairly valued, even though they trade with betas, measurement of systematic risk, that are below the market. Altria, for example, trades with a beta of 0.41 while Reynolds American carries a beta of 0.57.
Cigarette companies are ideal investments for a number of different reasons: Firstly, they pay a strong and sustainable dividend which is supported by earnings and cash flow growth. Secondly, Big Tobacco is extremely profitable and is able to operate at higher margins than other operators in the consumer discretionary space; returns on assets, returns on investment and returns on equity are substantially higher for tobacco companies than comparable consumer product corporations. Finally, the demand for their product is not affected by economic swings, thus providing a level of security to investors.
Whatever your personal preference about smoking, tobacco is a beneficial component of a portfolio. While many funds avoid sinful names like Lorillard and Phillip Morris, investment managers who incorporated them in their portfolio realized tremendous gains as a result.
Motley Fool newsletter services recommend Philip Morris International. The Motley Fool owns shares of Altria Group and Philip Morris International. apinkasovitch has no positions in the stocks mentioned above. 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.
