Continue Buying the Smoking-Hot Cigarette Stocks

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The cigarette stocks remain hot as high yields and steady growth have led to strong stock gains. Many an investor has overlooked the sector due to perceived negatives of the industry, but for an investor looking for yields and growth the sector should not be ignored.

Right now the leading domestic cigarette stocks of Altria (NYSE: MO), Lorillard (NYSE: LO), and Reynolds America (NYSE: RAI) all maintain dividend yields of at least 5%. Even more importantly the stocks have used excess cash to buy back cheap stock. Over the last three years these stocks have all had total gains in excess of 100%.

As the chart below shows, these stocks have dramatically outperformed the market over the last year:

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MO Total Return Price data by YCharts

Part of the recent excitement in the sector has been the big push into e-cigarettes, which claim to offer safer smoking than traditional cigarettes. The e-cig user inhales vapor created when a battery-powered tube heats a liquid nicotine solution, giving the person a hit without burning or smoke. The industry accounts for only 1% of sales today, but Wells Fargo analyst Bonnie Herzog predicts sales to ramp up quickly to $10 billion by 2017.

Market leader

Altria has long been the dominant tobacco and cigarette maker in the US. Even after splitting out the international operations into Philip Morris International, the company still has a market cap of $70 billion. The stock trades at a forward multiple of over 13 times earnings. Analysts only expect on average 8% earnings growth over the next five years. With revenue growth stalled at around $17.5 billion, the company will have a difficult time growing earnings any faster. The company spent over $1 billion on buybacks in 2012.

Altria has been slow to adopt e-cigs, but in August it will start selling the new MarkTen e-cigs in an Indiana market. Even late to the game, the market leader should be able to forge a strong position by leveraging existing contacts and shelf space.

Leading move into e-cigs

Lorillard is typically the under-the-radar stock in the group with the smallest market cap of only $16.4 billion. The company has a solid 5% dividend yield and has consistently repurchased shares in the last few years. The stock trades at the lowest forward PE in the group of just below 13, while analysts expect earnings to grow on average by nearly 10%. Lorillard spent nearly $600 million on buybacks in 2012 alone.

The company bought Blu e-cigs for $135 million last year and has quickly boosted distribution to 80,000 stores.

Highest dividend yield

Reynolds America has the largest dividend yield in the group of 5.3%, but the stock also trades at the highest forward multiple of over 14 times 2014 estimates. Analysts only expect earnings to grow around 7.5% in the next five years. The company spent $1.1 billion on buybacks during 2012 and started 2013 with $325 million in repurchases for Q1.

Reynolds plans a national roll-out of its Vuse e-cig starting next month in Colorado.

Bottom line

While the sector has seen strong gains in the last three years, the stocks still offer some of the highest yields in the market along with management teams that continue to see the stocks as attractive. Based on the fastest earnings growth and lowest earnings multiple, Lorillard provides the most intriguing valuation. Not to mention, the company has been the fastest to move into the growing e-cig segment and could obtain a dominant position before the two larger competitors even get going.

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Mark Holder and Stone Fox Capital Advisors, LLC own shares of Lorillard. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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