One of the reasons why value investing can be difficult to execute in real life is because the kind of companies offering the prospect of P/E expansion are usually working their way through some problems that make the stock unattractive at the time they offer the discount (unless you have a 2008-2009 type of situation in which everything is on sale). If things are moving along smoothly and you're getting your 10% growth every year, it's unlikely that you're going to get a good deal on the company when things are going well.
Philip Morris International (NYSE:PM) is one such company that generally reports profits that march upward, but due to difficulty in Russia and the Philippines, is reporting a temporary reprieve from its otherwise typical, linear profit growth. Over the past five years, Philip Morris International has grown profits at 9% annually. However, the profits have been slower growing since 2012, with the company's reported profits of $5.17 only growing to $5.26 in 2013 and on pace to stagnate in the same range for the rest of 2014.
This stalling in earnings growth has created a source of opportunity for investors, especially compared to the market as a whole. As of Friday's close, the S&P 500 as a whole traded at 19.72x earnings. Philip Morris International, meanwhile, trades at $84.34 compared to profits of $5.26, for a valuation of 16.03x profits. The discount exists because Philip Morris International has had trouble growing earnings per share over the past 24 months, and most likely, if you wait for the return to earnings growth before initiating a position, you will not be able to buy the stock as cheaply.
Why do I feel confident that earnings growth will return to normal? Well, you can already see that the company is growing revenues in the 4.5% range, and that figure has been driven down by the volume difficulties in Russia. For a "bad year", the company's figures seem to portend better things ahead when you can still grow top-line revenues while encountering difficulties in Russia and the Philippines.
Also, the ability of the company's flagship Marlboro brand to gain market share ought to bode well for shareholders going forward. In the European Union, Marlboro has increased its market share from 18.6% to 19.0%. In the Eastern Europe, Middle East, and Africa region, Marlboro's market share has increased from 7.0% to 7.1% (the rest of Asia experienced a similar tenth of one percent gain in market share as well). In Latin America and Canada, Marlboro's market share increased from 14.6% to 15.0%. Philip Morris International is shipping about 300 billion units of Marlboro across the world, and this growing market share ought to manifest itself in the form of higher earnings per share in the next few years.
The other source of opportunity for investors is the fact that earnings per share have been negatively impacted to the tune of $0.34 per share. On a constant-currency basis, the company's profits would be somewhere around $5.60 per share (meaning that the fundamentals of the company are stronger than would be indicated due to the current haircut that applies when the company's profits are converted into U.S. dollars). When the tide turns and the dollar weakens against the world currencies, then the opposite effect occurs - Philip Morris International's profits appear to be growing much higher than the actual business reality would indicate.
Additionally, the company offers a 4.5% starting dividend yield, which offers investors an opportunity to receive high current income while owning a stock that is not overpriced. The five-year dividend growth rate is 26.5%, although that figure is artificially high because Philip Morris International had a payout ratio of only 30% after its spinoff from Altria, and part of that high dividend growth is the result of the cigarette maker's payout ratio increasing from 30% to 65-70%. Most likely, the dividend growth will moderate towards the 8-10% range in the coming years to reflect the company's long-term earnings per share growth rate.
Philip Morris International seems like the dividend stock to buy in 2014 because, unlike many of its peers in the dividend growth universe, the shares are not pricey. This is because of the stalling earnings growth during the past two years, and is the explanation for why the stock currently offers a fair deal to shareholders. If you wait a year or two for earnings per share growth to resume, then the opportunity to buy the stock at 16x earnings may be gone as the P/E ratio may expand to reflect the improved business results once they arrive.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.