Editor's Choice

Slow and Steady Wins the Race in This Industry

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

The tobacco industry is not a haven for growth investors, nor should it be. Consumers continue the trend toward healthier living, and the decline of smokers has put a lid on growth. That’s largely behind the sell-off in Altria Group (NYSE: MO) after releasing second quarter earnings.

The market was clearly disappointed by the company’s 5% growth in adjusted diluted earnings per share, but this serves as yet another reason why buy and hold investors need to seriously consider adding Altria to their portfolio.

Steady growth, just the way Altria likes it

The merits of investing in Altria are fairly straightforward: a company that produces reliable growth (albeit not Earth-shattering growth), trades for a reasonable valuation, and pays shareholders a huge dividend.

That’s been the mix behind Altria’s multi-decade track record of excellent returns. In fact, according to noted economist Jeremy Siegel, Altria, formerly Philip Morris, was the top performing stock from 1925 to 2003.

Altria is never going to be a growth stock, and it’s a mistake for investors to avoid it because of that. It's true that smoking will continue to decline, but it's irrational to believe cigarettes will ever disappear.  Altria doesn't see the number of smokers increasing.  The company will continue to rack up profits through growth in other products, including smokeless tobacco, as well as the company's large take in brewing giant SAB Miller.

Altria’s second-quarter and first-half results were just what investors should expect. Altria grew its adjusted diluted EPS, which excludes special items, by 7.4% in the first half of the year.

Moreover, the company revised its full-year 2013 outlook. For the full year, Altria expects adjusted diluted EPS to fall between $2.36 per share to $2.41 per share, representing 7% to 9% growth versus 2012.

In addition, Altria is due for a dividend increase for its next payout. The company reiterated its intent to return 80% of adjusted diluted EPS to shareholders. As a result, we can deduce its likely dividend increase.

Assuming Altria hits at least $2.36 in per-share adjusted EPS, 80% of that would represent a dividend of roughly $1.88 per share. That means investors can reasonably expect a 7% dividend increase in the fall.

An important caveat: avoid this corner of the tobacco market

Of all the purported headwinds facing the tobacco industry, one that I do think has real traction is the ongoing scrutiny of menthol cigarettes. For years, menthol products were criticized for being even more detrimental to one’s health than traditional cigarettes. Now, the Food and Drug Administration is getting involved.

On July 23, the FDA said it would look into more heavily regulating menthol cigarettes. While I generally feel that rumors of the tobacco industry’s death are greatly exaggerated, on the topic of menthol cigarettes facing regulatory danger, there’s real precedent to fuel the fire of those fears.

In 2011, an advisory committee within the FDA ruled that removal of menthol from the tobacco marketplace would benefit public health greatly.  It's unclear if the FDA could outright ban menthol, but the fact that it's a possibility is reason enough to stay away from menthol.

As a result, I would diligently avoid those tobacco companies reliant on menthol products. This includes Lorillard (NYSE: LO) and Reynolds American (NYSE: RAI). Lorillard is the company behind Newport, and Reynolds American sells its Kool and Salem brands of menthol cigarettes.

Like Altria, Lorillard and Reynolds American are counted on for their dividends, which stand at roughly 4.8%, in line with Altria’s payout. And, Lorillard and Reynolds American trade for 14 and 17 times EPS, right in line with Altria’s valuation. Because of this, it’s easy to group the three tobacco titans together and assume they’re one and the same, but that would be a mistake.

Altria isn’t dependent on menthol, but it sold off on the news along with its two competitors.

Altria is simply the king of the domestic tobacco industry. The company’s juggernaut Marlboro brand, one of the most valuable product brands in the world, controls 43% of smokeable product retail share by itself.

If you consider yourself a Foolish investor, meaning you understand the merits of long-term, buy-and-hold investing, then you can see how valuable Altria can be for your portfolio. Because human beings have vices, often distasteful ones, and since states and municipalities desperately need cash now more than ever, Altria will be around for a long time to come.

I’m an owner of Altria shares, and I’d recommend investors join me.

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Robert Ciura owns shares of Altria Group. 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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