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Do You Smell Smoke in Tobacco Stocks?

February 17, 2012 | About:

Yield chasing has pushed tobacco stocks’ valuations to their multiyear highs, while the dividend yields from the stocks are at multiyear lows. While income investors do not have a lot of options left by the historical low bond yields, they may want to watch out. Don’t forget Warren Buffett’s rule number one while the party is going on nicely. Tobacco stocks have been very rewarding to investors. They are less volatile, and they generate far fatter dividends than bonds. But investors need to be aware that the dividend yield of tobacco stocks are at decade lows, while their valuations are at decade highs. Historically, valuations tend to reverse to their means.

The decade low yield of tobacco stocks can be clearly seen from our new interactive charts, which are embedded below. The chart shows the dividend yield of three tobacco stocks: Reynolds American (NYSE:RAI), Philip Morris International (NYSE:PM) and British American Tobacco (NYSE:BTI).

BTI,RAI,PM yield Interactive Chart

In 2003, when the tobacco industry was threatened by another large litigation risk, the dividend yield of Reynolds American (NYSE:RAI) was at 13%. In the market crash of 2008-2009, the yield was more than 10%. Today it is at a little above 5%. While 5% is high compared with the market average, only in 2005-2007 the yield was lower than its current value. We know what happened after 2007, the stock declined more than 30% in from 2008 to the first quarter of 2009.

The situation is even worse with Philip Morris International (NYSE:PM) and British American Tobacco (NYSE:BTI). The yields for both of them are at their historical lows.

Owning tobacco stocks has certainly been rewarding to investors. Besides generating nice dividends, the stock prices have also outperformed the market significantly since the last market peak in 2007. While the S&P500 is still below its peak, tobacco stocks have made new highs. See the price chart below for Reynolds American (NYSE:RAI), Philip Morris International (NYSE:PM) and British American Tobacco (NYSE:BTI).

BTI,RAI,PM Interactive Chart

While everything has gone well, the valuations are at their highest level. See the historical P/E of these three companies below:

BTI,RAI,PM pe Interactive Chart

A historical high valuation is usually followed by a reversion to the mean.

About the author:

Charlie Tian, Ph.D. - Founder of GuruFocus. You can now order his book Invest Like a Guru on Amazon.

Rating: 3.1/5 (16 votes)


Munger - 5 years ago    Report SPAM

I own some tobacco stocks and agree the valuation is at the high end (plus we've had some very nice returns the past few yrs) although I'm not just going down the list of historical yields. I don't agree with the point of suggesting a price decline is upon us by pointing out what happened the last time the yields were so low - noted by the RAI reference 2005-2007. That was right before ALL stocks took a major dive.

I'm sitting on some nice gains and I don't see any incredible buying opportunities so I plan to sit on 'em. Since the theme of the article is yield levels, I will point out that PM could easily increase its dividend 10+% and the yield would easily be back over 4% even at current prices. I expect PM to increase their dividend this year somewhere in the range of 12-15%. A 4%+ yield is not great as say the 6%+ during the big sell off in '08/'09 but not bad either. PM hasn't made their 2012 dividend annoucement yet (and MO for that matter).

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DBrizanrota16Jan2018 1143p
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doniemaherScreen #27 - ROI
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