A 5% Yield and a Great Value

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If I told you that I know a company with a 5% yield and that analysts expect EPS growth of about 9.6%, would you be interested? How about if I also told you that this same stock sells for a forward P/E of under 14? Now, let’s see if you are still interested when I give you the name: Lorillard (NYSE: LO). That’s about what I thought, of those who read the last sentence, I’m thinking only about 50% are still reading. The cold hard fact is, certain investors simply won’t consider investing in a company in the tobacco industry. That being said, the investment case for Lorillard is very simple, you get a great yield and earnings growth for a very reasonable value.

Let’s Get Right Down to It

Let me say up front that I understand the hesitation to invest in a tobacco company. However, if you have no such reservation, these companies offer some very compelling values. For instance, what other industry offers multiple companies with yields of around 4% to 5%, in addition to earnings growth of between 7% and 11%? When you combine these impressive numbers with reasonable P/E ratios, you could have a winning combination.

In fact, I would argue one of the best reasons for investors to consider Lorillard has to do with these very three metrics. Lorillard currently offers a yield of about 5%, and compared to its competition only Reynolds American (NYSE: RAI) offers a higher yield at roughly 5.2%. Whereas some investors might choose Altria (NYSE: MO) and its 4.8% yield, the comparison gets a little more difficult looking at Philip Morris (NYSE: PM) and its 3.7% yield.

If we look at each of these company's growth rates, Philip Morris is expected to grow the fastest at 11.23% over the next few years. Lorillard comes in a respectable second place with an expected growth rate of about 9.6%. Reynolds American and Altria, on the other hand, are both expected to grow earnings at a slower pace closer to 7.5%.

When you realize that Lorillard has the second best yield, and the second best growth rate, you might be surprised to find that the stock actually sells for the lowest forward P/E ratio. At just less than 14 times projected earnings, Lorillard is priced lower than the slower growing Reynolds American or Altria, which both sell for P/E ratios of over 15. While Philip Morris is expected to grow faster, its share value reflects this with a P/E ratio of about 16.4. As you can see, with the lowest valuation and the second best yield and growth, it seems investors are getting a lot of bang for their buck.

Organic Growth and the Future of Cigarettes

In the tobacco industry, one of the most difficult things is for companies to show real revenue growth. In fact, of the four companies we’ve looked at, only Philip Morris and Lorillard saw positive revenue growth in the last quarter. What’s particularly interesting, Lorillard doesn’t have the same growth profile as the internationally focused Philip Morris, yet the company reported revenue growth of 3.3%, which beat Philip Morris' growth of 3.2%. With both Reynolds American and Altria reporting revenue declines of at least 2%, you can see that top-line growth is tough to come by.

Maybe even more important to the tobacco industry’s future is a newer product called the e-cigarette. This relatively new concept is an area that Lorillard has taken an early lead in. For those who don’t know, e-cigarettes look like traditional cigarettes, but only contain nicotine. These devices allow the smoker to get the nicotine fix they crave but don’t contain the potentially harmful tar and other products in regular cigarettes. For both the smoker and for those around them, the best part about e-cigarettes is there is no smoke, but instead a water vapor is released. This allows smokers to enjoy what they crave and avoids the potentially harmful side-effects to both the smoker and those around them.

Lorillard has recently been advertising their Blu brand of e-cigarette with the idea that adults should “take back their freedom.” Since these devices seem to address all of the major health hazards of traditional cigarettes, a major switch to e-cigarettes could call into question smoking bans and other smoking unfriendly policies.

While e-cigarette sales only accounted for about $57 million of Lorillard’s current quarter revenue, as you can imagine, if this category catches on, it could change the tobacco industry forever. The difference between Lorillard and the competition is that Lorillard seems to have realized this opportunity first. Reynolds American said they would announce their Vuse e-cigarette “expansion plans soon,” and Altria said their Nu Mark brand “plans to introduce an ecig.” Lorillard’s first mover advantage could be a huge win for the company.

Quite simply, investors in Lorillard arguably get the best combination of traits in this industry. The company’s yield is high, they are expected to outgrow their domestic peers, their valuation is reasonable, and e-cigarettes could provide a sustainable way to grow the business. Investors should be careful not to overlook this opportunity, otherwise they may see their potential returns go up in smoke.

Altria has been the best-performing stock of the past 50 years, but as the number of smokers in the U.S. continues to steadily decline, is Altria still a buy today? To find out whether everyone’s love-to-hate dividend stock is a savvy investment choice or a hazard to your portfolio, simply click here now for access to The Motley Fool's premium research report on the company.

Chad Henage has no position in any stocks mentioned. The Motley Fool owns shares of Philip Morris International. 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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