Wall Street is always looking for ways to value stocks on a forward basis as future growth is more important than past growth. Investors want to know if a stock is likely to reward them with future gains. One such way is through the price-earnings to growth, or PEG, ratio. The PEG ratio was created by Peter Lynch, who averaged annual returns of nearly 30% while he was the portfolio manager of Fidelity Investments’ Magellan Fund (FMAGX) from 1977 through 1990.
The PEG ratio is calculated by taking the price-earnings ratio and dividing it by the projected earnings growth rate. For example, stock XYZ has a price-earnings ratio of 20 and is expected to grow earnings by 10% next year, giving the stock a PEG ratio of 2. A stock with a PEG ratio below 1 means it is undervalued as the projected growth surpasses the value the market places on the company. Lynch used this ratio to help him deliver the incredible returns that he had.
With the current bull market the longest in history and the S&P 500 trading with a price-earnings ratio of 25.4, investors might think there are very few bargains left in the marketplace. There are some stocks that trade with a low PEG ratio. One such company is Altria Group Inc. (MO, Financial).
Company background
Altria was originally founded by Philip Morris is the 1840s. Since then, the tobacco giant has become one of the largest consumer staple companies. The company spun off Kraft Foods (KHC, Financial), which later merged with Heinz, in 2007. Altria spun off its international operations in Philip Morris (PM, Financial) the very next year. Today Altria sells its products just in the U.S. Altria’s flagship Marlboro cigarette brand is the number one tobacco product in the country. The company also sells non-smokeable brands, such as Skoal and Copenhagen. Altria also has a 10% ownership stake in Anheuser Busch Inbev (BUD). The company has a current market cap of almost $118 billion.
Recent earnings results
Altria most recently released earnings on July 26. The company earned $1.01 per share during the second quarter, 1 cent above the average analysts’ estimate. Earnings per share increased 19% from the second quarter of 2017. Subtracting excise taxes on products, Altria saw revenue decline 3.7% to $4.9 billion. Federal and state governments have placed excise taxes on tobacco products with the goal of reducing smoking rates while bringing in revenue.
Revenue has dropped for Altria for some time as the company deals with declines in smoking. As recently as 2016, 15.5% of adults in the U.S. were smokers, down from 20.9% in 2005. Total volumes shipped decreased 5%, above the sector average of a 3.5% drop. When adults do smoke, they tend to go with Marlboro. As the top-selling brand, Marlboro does have some pricing power. The average pack cost $6.79 during the second quarter, more than 2% higher on a year-over-year basis.
To help address the decline in smoking rates, Altria has brought new products to market. The company’s non-combustible product line includes e-vapor and e-cigarettes. Nu Mark, Altria’s e-vapor product, saw a 16% rise in volumes during the second quarter. Nu Mark is now available in more than 23,000 retail stores across the country. The company’s iQOS product line is awaiting the Food & Drug Administration's approval. IQOS products heat tobacco, rather than burning it, which could help limit the harmful side effects of smoking.
Altria expects to earn between $3.93 and $4.03 per share this year. Achieving the midpoint of this guidance would represent 16% to 19% growth from 2017.
Dividend history
Altria has increased its dividend for the past 49 years, likely setting up the company to become a Dividend King in the very near future. The company has one of the longest dividend growth streaks in the market. Only 28 other U.S. companies have a longer dividend growth streak. The company has increased its dividend:
- By an average annual rate of 8.3% over the past three years.
- By an average annual rate of 8.3% over the past five years.
- By an average annual rate of 11.3% over the past 10 years.
More recently, Altria raised its dividend 6.1% for the payment this past April and then 14.3% for the upcoming October payment. In total, shareholders of Altria will receive $2.86 per share in dividends for this year, 15% more than in 2017.
Based off of the midpoint for expected earnings per share for the year ($4), Altria will have a dividend payout ratio of 71.5%. On the face of it, this is a very high payout ratio, but Altria has a stated policy of returning at least 80% of earnings per share to shareholders. The average dividend payout ratio from 2008 through 2017 was 83.8%. The difference in the current ratio and the historical average leaves the company room to continue to increase its dividend.
With nearly five decades of dividend growth, Altria has navigated numerous economic cycles and still managed to increase its dividend. As of last Friday’s closing price, Altria shares trade with a dividend yield of 4.48%, well above the yield of both the S&P 500 (1.74%) and the 10-Year Treasury Bond (3.07%).
Altria is a very shareholder-friendly company. In addition to multiple dividend increases this year, the company repurchased 7.6 million shares in the most recent quarter. The company paid an average price of $57.65 per share, spending more than $438 million on buybacks. The company still has more than $1 billion remaining on its current share repurchase authorization. The company intends to complete this purchase sometime in the second quarter of next year.
PEG ratio for Altria
Earnings growth, dividend streaks and buybacks are all well and good, but if the stock valuation is too high, then it does investors no good. How does Altria rate when we examine the company’s PEG ratio? In my opinion, very well.
Shares of Altria closed at $62.55 on Friday. With a midpoint for expected earnings per share of $4 in 2018, this gives the stock a price-earnings multiple of 15.6. Given that the company expects the midpoint for earnings growth to be 17.5%, Altria’s stock has a PEG ratio of 0.89. Again, a PEG ratio below 1 for a stock is considered to be bullish as this means the growth rate exceeds the current valuation.
I should note the PEG ratio isn’t the only valuation method that finds Altria to be undervalued at the moment. The company’s average price-earnings multiple from 2008 through 2017 was 16.2. Compared to its own history, Altria is slightly undervalued today under this method as well.
Final thoughts
While there are a variety of ways to value stocks, the PEG ratio allows investors a simple way of determining if the market is undervaluing a stock. With a PEG ratio below 1, the stock would appear to be undervalued as the market seems to be ignoring the company’s growth rate. Altria’s dividend history is impressive and the company has a very shareholder-friendly attitude. With Altria's stock dropping more than 12% this year, perhaps the market is giving investors an opportunity to pick up shares of an undervalued company.
Disclosure: I am not long any of the stocks mentioned in this article.
