One of my favorite industries for the long term, and this surprises a lot of people, is the tobacco industry. Never mind your personal thoughts on cigarette makers or the tobacco industry in general, and don’t let the apparent “no smoking” trend fool you–tobacco can still mean big gains for its shareholders.
As a former smoker myself, I was surprised to learn about the high yields and expected growth from the tobacco industry. Where smoking used to be “cool,” the youth of today seem to see things differently. When I was in high school, most kids bought their first legal pack of Marlboros on their 18th birthday. A couple decades later, as a high school teacher myself, I get a firsthand look at the latest trends with our youth.
Most teenagers these days seem to think cigarette smoking is one of the most disgusting things in the world, and that there is nothing at all “cool” about turning 18. Sure, you can vote, but you’re now an adult that can be held responsible for your own bad decisions. I actually had a student tell me that the other day. Man, times have changed!
So Why Invest In Tobacco?
However, there are two main points that investors miss. First of all, a lot of countries around the world are much more accepting than we are when it comes to smoking, particularly in the developing world. Second, while the percentage of U.S. smokers is indeed on a downtrend, the number of smokers doesn’t have to be.
Let’s say that in 1950 there were 100 million adults in the U.S., 60% of whom smoked. That makes 60 million smokers. If only 25% of adults today smoke, but the population has grown to 300 million, that makes 75 million smokers, or 25% more than in 1950. Keep in mind that these are not actual statistics–I’m just making the point that the number of smokers isn’t necessarily declining.
The Candidates
1.) Altria Group Inc. (NYSE:MO) is the largest cigarette producer in the United States, and was formerly known as Phillip Morris Companies. Altria produces such brands as Marlboros, Virginia Slims, and Parliaments, and does approximately $25 billion in annual sales. The shares currently trade at 14.1 times forward earnings, and with just 7% growth projected annually, this may seem expensive. However, the great dividend yield (5.2% currently) and track record of dividend raises makes this company worth a look for any dividend investor.
It is also worth noting that there is another option if you are exceptionally bearish on U.S. tobacco sales. Altria spun off Phillip Morris International in 2008, which consisted of all of the company’s non-U.S. operations. The company has more aggressive expansion ambitions than their American counterpart, and is particularly eager to expand into China, India, Bangladesh, and Vietnam, who combined account for 40% of the world’s smokers–however, Phillip Morris’ products have virtually no presence in those areas. Analysts are projecting a 12% forward growth rate, with the tradeoff being a lower dividend–it’s currently at 3.7%.
2.) Reynolds American Inc (NYSE:RAI) is the second largest U.S. tobacco company, with popular brands such as Camel, Kool, Pall Mall, Doral, and Winston cigarettes. The company is also a leader in smokeless tobacco through its Grizzly and Kodiak brands. Reynolds currently trades at a valuation of 13.3 times forward earnings with a 7% forward growth rate, which is a bit more attractive than Altria Group Inc. (NYSE:MO), as is its 5.5% dividend yield, which has been raised every year since 2006.
3.) The third largest U.S. tobacco company is Lorillard Inc. (NYSE:LO), with brands that include Newport (the second highest seller to Marlboro), Kent, and Maverick. Lorillard is projected to have the best forward growth rate of the American companies (9%), and also trades at the cheapest valuation at just 13 times forward earnings. They also pay the best yield at 5.6%, and have raised the payout by over 200% in the past decade alone.
So What To Do?
Which particular company is best for your portfolio depends on what your particular goals are and what level of risk you are comfortable with. The smaller companies generally are the best bargains, but are generally more volatile when the market goes sour. In the tobacco industry specifically, smaller companies are more susceptible to lawsuits. A $1 billion lawsuit will affect Altria Group Inc. (NYSE:MO) and Lorillard (whose sales are about one-fifth as much) in very different ways!
Personally, I tend to focus more towards growth than income, being that I’m still a long way from retirement age. As a result, I prefer Phillip Morris International because I think that with the two most populated countries on Earth as untapped markets, even the 12% projected growth strikes me as a little low.
Whichever is best for you, invest without emotion. While a lot of investors view an investment in big tobacco as profiting from the pain of others, I prefer to think of their high returns as a “refund” of some of the money they made from me during my 20’s!
The article This Industry Means Big Yields! originally appeared on Fool.com and is written by Matthew Frankel.
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