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During this analysis I will utilize my investment strategy outlined in my first article.

To summarize, I use a weighted analysis of cash flow, liquidity, profitability, return, size and valuation. I chose ten metrics that I deem crucial to my portfolio. They are: Current Ratio (4%), Long-term Debt to Assets (5%), Cash Flow per Share (10%), Net Profit Margin (6%), Dividends (5%), Market Capitalization (1%), Shares Outstanding (1%), Price to Cash Flow (25%), Free Cash Flow to Operating Cash Flow (23%), Operating Cash Flow to Sales (20%). To perform my analysis, I rank each of the companies against one another based on their performance of each of these metrics. Therefore, if I rank five companies, the strongest score would be five, by virtue of receiving a five rating in every category.

For purposes of this article, I have analyzed five companies in the tobacco industry with regard to their third quarter 2013 information. Going forward, I would like to conduct this type of analysis on a quarterly basis. The companies I chose are: Lorillard (NYSE:LO), Altria Group (NYSE:MO), Philip Morris (NYSE:PM), Reynolds American (NYSE:RAI) and Vector Group (NYSE:VGR). Here is how each of the companies performed:

 

 

 

Weight

LO

Rank

MO

Rank

PM

Rank

RAI

Rank

VGR

Rank

Price (1/13/14)

 

$49.27

 

$37.09

 

$82.45

 

$48.11

 

$16.37

 

Market Capitalization

1%

18.15

2

74.18

4

132.42

5

26

3

1.6

1

CF/Sh to price

10%

3.05%

2

3.24%

4

2.50%

1

3.36%

5

3.13%

3

Shares Outstanding

1%

368

2

2,000

5

1,610

4

540.45

3

97.48

1

Dividend %

5%

4.47%

1

5.18%

3

4.56%

2

5.24%

4

9.77%

5

Current Ratio

4%

1.83

4

0.91

1

1

2

1.21

3

2.17

5

LTD to Assets

5%

100.45

1

35.86

4

59.46

2

30.76

5

57.73

3

Net Profit Margin

6%

14.12

3

21.3

4

11.64

2

21.41

5

-13.59

1

P/CF

25%

14.7

4

15.7

3

14.3

5

20.1

2

35.5

1

OCF/Sales (CF Margin)

20%

30%

3

51%

5

16%

1

41%

4

18%

2

FCF/OCF

23%

97%

4

98%

5

91%

1

95%

3

94%

2

 

100%

 

3.20

 

4.02

 

2.27

 

3.42

 

2.09

Weighted Analysis

Based on my analysis Altria Group is the strongest tobacco company to add to my portfolio. As explained earlier, I place the most emphasis on cash flow. As you can see MO ranks very high with metrics that are a derivative of cash flow. Thereby, leading to its strong rating.

Cash Flow

It is really interesting to see the strength of cash flows when analyzing tobacco companies. Particularly, the fact that each of the companies I analyzed had a FCF/OCF ratio above 90%. Of the different sectors I have analyzed, the tobacco industry has by far the strongest free cash flow to operating cash flow ratio. Due to such a high ratio of free cash flow these companies will continue to create tangible value for investors.

Additional Considerations of Return

As of third quarter MO raised their dividend 9.1%. Due to this factor, investors will have to consider the fact that dividends may not be raised for several quarters. The current rate of 5.10% is a great add to most portfolios. Moreover, the board of directors authorized a $1 billion share repurchase program which will be completed by the third quarter of 2014. As of 9/30/13 MO has $709 million remaining in this share purchase program. Many different assumptions can be made about the amount of shares repurchased in fourth quarter 2013, but MO will likely have to make significant purchases during the course of 2014. Through this repurchase program MO shareholders should continue to see value at least through 2014. Generally, I prefer to hold stocks for 3-5 years. I believe MO definitely fits within this time horizon. However, the changing adult health dynamic may result in difficulties for tobacco companies. Therefore, this analysis will need very careful attention on a quarterly basis.

I invite you to please provide feedback as I plan to develop my strategy, profile and system in the future. I take find criticism and questions very beneficial.

Source: Altria Group's Free Cash Flow Is On Fire