When I first started reading a recent edition of Dr. Jeremy Seigel's famous work Stocks for the Long Run, the most revealing insight that I stumbled upon is that over the fifty-year stretch from 1957-2007, the best American stock that you could have purchased was Philip Morris (now Altria - MO).
The King of Big Tobacco produced an average annual return of over 15% during that half-a-century period. A $1,000 investment into Philip Morris in 1957 would have turned into $1.7 million in 2007. As Warren Buffett said about the tobacco industry in 1990, 'The product costs a penny to make, you can sell it for a dollar, and it's habit-forming. What more do you want?' Of course, long-term tobacco investors might retort, ‘Less regulation. Lower cigarette taxes might be nice. And let’s not add pictures of people dying to the outside of cigarette packs.’
But all that’s beside the point. The pressing question before us ought to be: Is Altria an intelligent investment right now?
What makes Altria more difficult to evaluate than a typical large-cap company is the amount of variables out of Altria’s control. Taxes are the first thing that comes to mind. When a state government has a budget out-of-whack, what’s it going to do? Do you think a politician is going to cut senior services, or tack on an additional dime to the price of cigarettes? Raising cigarette taxes have become an annual ritual in some states, and that sure as heck isn’t going to help increase the amount of Altria’s sales.
And cigarette companies have explicit bans forbidding them from advertising their product in an enticing manner. Or even at all—the government has outright banned cigarette companies like Altria from producing commercials on TV channels. You’re not going to see the Marlboro Man alongside Ronald McDonald on the airwaves any time soon.
And lastly, and perhaps most importantly, most states are ratcheting the bans are the number of places you’re allowed to smoke. Twenty-three states have passed laws forbidding bar patrons from lighting up in bars that derive more than 25% of their revenue from food. Widespread smoking bans aren’t conducive to cigarette companies growing their profits.
But let’s take a look at Altria’s numbers. Altria recently announced a buyback program to repurchase $1 billion worth of Altria shares. If you assume that Altria is able to repurchase each share at a price around $25, that will enable Altria to reduce its share count by 40 million. There are currently 2.1 billion shares of Altria outstanding. This repurchase program ought to reduce the shares by about 40,000,000/2,100,000,000=1.9%.
And looking at Altria’s earnings growth, it’s easy to see how long-term investors probably take an ‘I’m laughing all the way to the bank’ approach to articles that predict a doomed future for the company. Earnings per share were $1.66 in 2008, $1.76 in 2009, and $1.87 in 2010. In the first half of 2011, Altria has earned $0.97 per share, putting the company on pace for $1.94 in earnings (most analysts are estimating slightly over $2.00 per share). If Altria hits the $2.00 per share mark by the end of the year, that would represent a 20% total earnings increase since 2008.
What usually draws investors to Altria is its historically dependable dividend that increases significantly every year. Altria has recently committed to paying out 80% of earnings to investors as dividends, which, if sustainable, goes a long way towards creating wealth. Altria paid out $1.30 in dividends in 2009, $1.42 in dividends in 2010, and most likely a total of $1.52 per share in 2011. If you can buy in at $25 per share, your initial dividend yield would be 6.08% per share.
That’s not bad, but by the fundamental metrics of the past few years, Altria shares appear to be a bit pricey. Since 2008, Altria has had an average P/E ratio of 12, and an average dividend yield of 7.5%. Based on the trailing 12-month earnings, Altria’s P/E is 15.63 and its dividend yield is hovering around 6%. If you want to buy Altria at the same P/E ratio it has averaged over the past 3.5 years, you would want to be paying just under $20 per share.
I've never taken the plunge on Altria stock, not due to some grand moral stance against tobacco, but because every year, it seems tobacco is getting taxed more and banned in more places, which leads to fewer smokers. Those demographic trends worry me as a potential investor. Even the old-guard tobacco executives shared this concern. That’s why, back in the day, you saw companies like RJ Reynolds gobble up Nabisco, and Philip Morris added Kraft to its portfolio. Having diversified income streams helped insulate tobacco giants from the potential demise of the cigarette industry.
But that diversification has largely evaporated. Altria still owns a 27% stake in SABMiller and some wineries, but that’s not as reassuring as having a snack company under your umbrella. I would think that the most risk-adjusted approach to investing in Altria would be to buy in at around $20, elect to not reinvest the dividends, and then use the 7-8% dividend stream to make other investments.