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On the economics side, Altria (NYSE:MO) is an interesting business in that it does everything it can to return to shareholders almost all the cash it generates from Marlboro, Virginia Slims, Merit, and Benson & Hedges cigarettes, wine operations, smokeless tobacco products, and dividends from a 27% interest in SABMiller (as an aside, the 27.0% stake in SABMiller is one of the most often overlooked assets on the Altria balance sheet that separates the company from its peers).

Since about 2010, Altria seems to be following a formula that permits the company to give shareholders an almost double-digit dividend increase for the next four of five years. That formula is this: continuously buy back stock, increase earnings per share organically at a 6-7% clip (before taking into account the favorable effect that the buybacks have on earnings per share), and keep as little amount of retained earnings as possible on hand (and thus allowing the earnings per share growth to directly translate into a dividend growth rate that puts more and more money into accounts of its owners).

From an income perspective, a company that gives you a starting yield north of 5% and grows at a rate around 8-10% starts to produce very large blocks of annual income relative to the amount of initial capital that you deploy into the company. Check out this chart courtesy of F.A.S.T. Graphs that illustrates the rapid share accumulation that occurs when you reinvest a large, growing dividend.

(click to enlarge)

Unfortunately, the data set is not particularly analogous to our situation because the only meaningful data set with the "new" Altria occurred at the start of the 2009 year (before that, Mondelez, Kraft, and Philip Morris International were a part of the company. And keep in mind that there was no true 38% dividend cut, but rather, a spinoff of what are now three different publicly traded businesses). Although the 24.5% annual returns won't be repeated over the next few years because of Altria's artificially low valuation at the start of 2009, that does not mean there is nothing we can learn from it. The point is to be looking at those 10-15 shares that keep getting added each quarter.

When you strictly look at Altria's dividend growth since becoming a standalone company, it has been nice: the dividend of $1.32 per share in 2009 has grown to $1.92 now. But that is only half the story. For people that reinvest, the share count rises rapidly, and this increase in the base of shares generating dividend has a hidden effect of amplifying income in a way that is not readily apparent just by looking at a stock chart.

If you bought 604 shares at the start of 2009, it might just look like your dividend has grown from $797.28 to $1,159.68 over the past five years. But the real story is much more impressive than that because the share base has simultaneously increased significantly (for those that have chosen to reinvest) in addition to the dividend payout: in just five short years, your share count would have grown from 604 to 796 shares. That means the annual dividend has actually grown from $797.28 to $1,528.32. Five years of reinvesting Altria dividends comes close to almost doubling your dividend incoming and giving you a 15.28% yield on cost in just five short years.

But it is important to keep in mind why Altria would currently be paying $0.15 on every dollar that you invested into the stock five years ago. Some of it has been organic dividend growth: 49.5% has come from the organic growth of the dividend, but 50.5% of your current income with Altria would have been the result of checking the "reinvest dividends" box on your brokerage screen.

Although the low valuations of reinvested dividends "turbo-charged" the growth in income over the past four years, there is still a good chance that this formula of double-digit increases in annual income could continue in effect for the next four of five years.

For Altria to continue giving shareholders 10-13% annual growth income, you need three conditions to be met:

(1) High Current Dividend Yield

(2) High Single-Digit Dividend Growth Rate

(3) Reinvested Dividends at Decent (Or Better) Valuations

As of right now, Altria's dividend yield is north of 5%. Check.

The next thing you need is an organic dividend growth rate somewhere around 8-10% annually. Check. The company has started making a commitment to reducing the share count as of 2010; with a share count of just under 2.1 billion declining to under 2 billion within the next few months. Although it depends on valuation, the company is taking 2-4 million shares off the books every month. Due to the SABMiller holding, price increases in cigarettes to offset declining volume, and the growth in the smokes tobacco market, Altria seems likely to continue growing at 8-10% annually over the medium term.

And then, it's just a matter of valuation-the lower the stock price, the more effective reinvested dividends are at increasing the dividend income you generation. Check. Right now, Altria is making $2.56 per share. While not especially cheap, you are still receiving nice increases in income when you reinvest a large chunk of income at a 14x earnings valuation.

If your primary objective with a potential investment is to see 10% or greater gains in income generated, then it seems that Altria should fit that bill over the next couple of years. A fairly valued stock with a 5% dividend that is growing at a rate of 8-10% annually can get you there as long as you reinvest the dividends and the valuation does not become absurd, such as advancing to 20x earnings or something like that. Jeremy Siegel, when discussing why the old Philip Morris was the best investment from 1926 to 2006, pointed out that high dividends, high dividend growth rates, and reinvestment at satisfactory or better valuations were the key to tobacco's historic success. For the next few years, that pattern of income wealth creation should continue.

Source: Altria: 10-13% Annual Dividend Growth When You Reinvest Dividends