The tobacco industry and tobacco stocks have long been a haven for income investors. The reason is simple: Tobacco companies enjoy a highly lucrative business model.
Their products cost little to manufacture thanks to economies of scale and efficient distribution; tobacco companies are banned from advertising in the U.S., which keeps marketing spending low; lastly, cigarettes are addictive, which leads to incredible pricing power.
This is why tobacco stocks have typically paid dividend yields well above the average stock. Today, their dividends are more valuable than ever. With interest rates remaining near historic lows and likely to rise only at a gradual pace, income investors should continue to light up the tobacco stocks for dividends.
Top Tobacco Stocks: Altria Group (NYSE: MO)
One could argue, without exaggerating, that Altria is the best dividend stock of all time. Noted economist Jeremy Siegel wrote in his 2003 investing book, “The Future for Investors: Why the Tried and the True Triumph Over the Bold and the New,” that Altria returned 17% per year from 1925-2003, making it the best-performing stock in the entire market in that period.
Think about that for a second: Altria’s 17% annualized returns would have turned $1,000 into more than $200 million in that nearly 80-year time frame.
The secret to Altria’s returns was two-fold. First, Altria paid a high dividend yield throughout, as it does today. The second aspect was that Altria consistently traded for a cheap valuation, which allowed investors to reinvest their dividends at a low price, thereby accelerating the magic of compounding.
Altria is a cash cow. It generated $5.6 billion of free cash flow last year, which easily covered its dividend and provides more than enough cushion to continue raising the dividend each year. Altria has raised its dividend 49 times in the last 46 years, and it currently yields 3.4%.
Top Tobacco Stocks: Philip Morris International (NYSE: PM)
Philip Morris International operates the Marlboro brand outside the United States. It was spun off from Altria in March 2008, and since its IPO, it has performed extremely well for investors. Philip Morris International stock has returned 103% since its IPO, versus 64% for the S&P 500. And, this return calculation does not even include its dividend payments.
Its excellent returns are due to rising earnings and capturing additional market share in the emerging markets. Last year, Philip Morris International’s adjusted earnings increased 12% from the previous year, thanks to an increase in market share. Total companywide market share rose 0.2% to 28.7%.
Such strong earnings growth powers Philip Morris International’s dividend growth. Since its IPO, the company has delivered eight consecutive annual dividend increases. Its payout has grown 121% in that time.
Currently, Philip Morris International offers a 4% dividend yield.
Top Tobacco Stocks: Reynolds American (NYSE: RAI)
Reynolds American has undergone a significant restructuring of its brand portfolio in recent years, with the goal of pursuing the highest growth opportunities and streamlining its cost structure.
In 2014, Reynolds American bought rival Lorillard for $25 billion, a huge deal that combined the No. 2 and No. 3 tobacco companies in the U.S. Then, it sold the international rights to the Natural American Spirit brand to Japan Tobacco for $5 billion.
This cash will be used to pay down debt to strengthen the balance sheet, buy back stock to boost earnings growth and reward shareholders with dividend increases.
Reynolds America’s adjusted earnings rose 15% over the first half of 2016, due to its cost cuts and pricing increases. The company expects full-year adjusted EPS to grow 14%-18% from 2015.
Such strong profitability and growth allows the company to richly reward its shareholders with cash returns. After a better-than-expected performance to start the year, the company said it will increase its dividend by 9.5%, and will repurchase $2 billion of stock over the next two years.
Today, Reynolds American stock is an attractive choice for value and income. The stock trades for a P/E of 13 and offers a 3.5% dividend.