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High-Yielding Tobacco Stocks Becoming Riskier Than Investors May Think

August 07, 2012 | About:
Holly LaFon

Holly LaFon

276 followers
Tobacco stocks have been on a tear for several years. In the shorter term, stocks of companies in the industry have increased 14.3% on average so far in 2012. At the same time, the 10-year Treasury yield fell to record lows at the end of July and is at 1.59% on Tuesday, sending investors looking for higher yielding equities, such as tobacco stocks. The average dividend yield for the top five market cap tobacco stocks is 4.42% significantly higher than Treasuries and the average yield of the S&P, which is near 2.61%.

While not safe for health, investors may be perceiving cigarettes as rather safe for their money as the companies have continued to produce strong earnings, raise dividends and grow globally despite economic uncertainty. However, the stocks’ yields may seem high, but they are actually down from their historical averages as investors push the prices up, which has heightened risk.

Reynolds American (RAI), for instance, has the highest yield of all cigarette stocks at 5.16%, according to GuruFocus’ all-in-one screener. This is close to a five-year low. The yield has declined as the price has risen:

RAI yield Interactive Chart



The company’s P/E ratio is also near a five-year high:

RAI yield Interactive Chart



Philip Morris international (PM), the largest cigarette company by market cap at $154.2 billion, has a dividend yield of 3.37%. But its dividend yield has been on a downward trajectory since it spun off of Altria (MO) in 2008. Meanwhile, the stock advanced almost 86%.

PM yield Interactive Chart



The company has been raising its dividend since it became an independent company:



Altria Group (MO) owns the all-time best-selling cigarette brand, Marlboro, along with several other brands. It has a dividend yield of 4.69%, a one-year low. It pays out about 80% of its annual earnings in dividends. The company’s stock has increased approximately 35% over the last year:

1216246701.jpg

The company’s P/E ratio has also climbed to historical high territory:

MO pe Interactive Chart



Lorillard (LO), the fifth-largest cigarette company by market cap, and third-largest cigarette maker in the U.S., has a dividend yield of 5.04%. Its dividend yield has fluctuated more than its peers, and its price is up the most, at 65% over the last year:

LO yield Interactive Chart



The company has the lowest P/E at 15.13:

LO pe Interactive Chart



Tobacco investor Tom Russo said in an October 2011 speech that he liked tobacco stocks because most of their shares were held outside the U.S., and they were undervalued:

“I think of two companies in which we have investments, British American Tobacco (BTI), and one of them is Philip Morris (PM). They both are global tobacco companies, neither of whom directly operate in North America because of fears over litigation. In the case of Philip Morris, only 6% of their shares are held outside the United States. So it gives you a sense. It’s extraordinary. They have 100% of their business non-U.S., but because it’s incorporated in the U.S. for tax purposes, though based in Switzerland, the foreign market just doesn’t touch it. So we still have the benefit, by having a global perspective. We can buy BAT, we can buy Philip Morris, but if 94% of foreign money doesn’t desire to look at Philip Morris because it has a U.S. listing and we can buy the global non-U.S. tobacco leader at a price that doesn’t reflect its fair value because of silo-ed capital, we’re still given a bit of an advantage for having a global perspective. “

Though high-yielding tobacco companies have continued to show strong financial results, with each of these companies producing earnings per share growth in the face of macroeconomic headwinds, the escalation of their prices as most investors get involved and shrinking of their dividend yields compared to historical averages could be heightening risk more than investors may think.



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