Can These High Yielders Provide Growth as Well?

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

Investing in high yielding growth stocks when the markets are choppy is a logical choice. However, not all companies can offer sustainable growth and dividend payouts, at the same time. Hence it’s important to look into the financial metrics before creating an income-growth portfolio.  The following companies belong to the tobacco industry, which generally offer steady but stable returns to its investors. The growing health concerns might put a negative pressure on the tobacco industry, but the legalization of recreational marijuana in Washington DC presents tremendous growth opportunities for the industry. Additionally, if other states also follow suit, the tobacco industry could very well be “the next big thing.”

Philip Morris (NYSE: PM) has its presence in more than 180 countries, with a diversified product line-up. Its management slightly lowered its 2013 guidance, and the market seems to have overreacted. Shares of Philip Morris have slid by 11% over the last couple of months. However the company enjoys a healthy gross margin of 27.15%, and its shares yield a hefty 4.1%. Additionally the company has reported a series of impressive growth in revenues, income and margins, and its shares have outperformed its peers YTD.

Earlier this year, its board approved an $18 billion share repurchase program, which would be carried out over a 3 year time frame. This move would not only bolster its EPS growth, but also boost the dividend yield by nearly 13.2%. The company ended the quarter with cash reserves in excess of $4.8 billion, with no significant debt on its books, ensuring sustainable dividend payouts. Analysts estimate its annual EPS growth would average around 10.1% for the next 5 years and I believe that Philip Morris is a good stock to hold, despite the guidance cut.

Shares of Lorillard (NYSE: LO) are flat YTD, but it’s still a good stock to hold. Besides having a high yield of 5.37%, the company enjoys an ROI of 59.22%, which is way higher than any of its peer’s. Additionally its gross margin of 36.34% is higher than the industry average. The company had $946 million in cash and cash equivalents by the end of Q2, and its board approved its $500 million worth of share buybacks and this alone would boost the annual EPS by 3.32%. Lorillard also reported a fractional increase in its top line and market share. Its adjusted net income rose by 5.7%, but somehow this wasn’t good enough for the street. With a forward P/E of 12.68x its shares appear to be undervalued and analysts estimate its annual EPS growth to average around 8.7% for the next 5 years. According to my calculations, strong fundamentals and rising profits should take this stock to at least $124 (around 10% premium).

Reynolds American (NYSE: RAI) also carries a high yield of 5.65%, but it appears to be overvalued with a PEG of 2.26x. Additionally its P/FCF comes out to be ridiculously high, and the company pays out 86.73% of its earnings. Its debt/equity of 74% is higher than the industry average, and there’s absolutely nothing impressive about its fundamentals.  British American Tobacco (NYSEMKT: BTI) also seems to be accompanying RAI. Though the shares of BTI might appear to be undervalued, its debt/equity ratio of 157% is simply the worst in the industry. Its shares trade at a P/B ratio of 8.42x and a P/FCF of 54x, indicating that BTI should be missed. In my opinion, its negatives outweigh the 4.2% yield (with a 80% payout ratio), and investors should stay distant from this one as well.

PiyushArora has no positions in the stocks mentioned above. The Motley Fool 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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