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I’ve written previously about the advantages enjoyed by companies after undertaking a spinoff, and the potential outperformance that investors can achieve by investing in the stock of those companies. Philip Morris International (NYSE:PM) has been the poster child for just how well a spinoff can work. Since being divested from parent company Altria (NYSE:MO) on March 31, 2008, both the company and the stock have performed exceedingly well. PM has gone from $50.58 on its first day of trading, to $71.64 on Friday, November 11, for a return of 41.64%. Over the same period, the S&P 500 went from 1322.70 to 1263.85, or a loss of 4.5%. This example ignores the effect of dividends, which is something we definitely don’t want to do with PM, as it has also proven to be a dividend dynamo during its first 3 years of independent operations.

I generally consider myself to be a “mean-reversion” investor, looking for companies that have underperformed recently to trade back up to normalized levels, and companies that have outperformed to stall and come back to earth. However, even given PM’s recent outperformance, I still think it makes an excellent investment, for everyone from older investors looking for current income in retirement to younger investors like me looking for growth to fund a retirement 40 years from now.

PM is the world’s leading international tobacco company, with products in approximately 180 countries outside the US, and a 27.6% share of the international market, excluding China, where state-owned China Tobacco has a monopoly. PM is the owner of Marlboro, the world’s strongest tobacco brand. In 2010, PM shipped 297.4 Billion units of Marlboro, more than double the next two largest brands combined.

The fact that PM operates outside the US provides the company and investors with a couple important advantages. First, it is exposed to less litigation risk than its former parent MO, which operates only in the US, and second, it has the opportunity for growth, as tobacco use internationally is still expanding. Another bonus in the current environment has been exchange rate movements that have positively impacted PM’s financial results. If you are worried that current Fed policies will lead to a weaker US dollar, an investment in PM could be an effective way to hedge that risk.

The advantages I mentioned above are certainly important, but it is PM’s policy of rewarding shareholders with both dividends and share repurchases that I view as the most important factor in making the stock a solid investment. Since its spinoff in 2008, PM has increased its dividend from an annualized rate of $1.84 to $3.08, or 67.4%. The $3.08 payout gives it a current yield of 4.3%. The payout ratio based on TTM earnings of $4.71 per share is 65%, which I view as quite comfortable given the predictable nature of PM’s cash flows.

PM sells a product that hasn’t changed much in the past 50 years, and probably won’t change much over the next 50 – this means the company needs to spend very little on research and development. Unlike Apple (NASDAQ:AAPL), PM does not need to come out with a new iteration of its flagship product every year. This means that the mountains of cash it generates each year can be safely returned to shareholders, without negatively impacting the ability of the business to continue to be successful. I think it is informative to look at PM’s dividend history.







Sep 14, 2011

Sep 23, 2011

Sep 27, 2011

Oct 11, 2011


Regular Cash

Jun 8, 2011

Jun 21, 2011

Jun 23, 2011

Jul 11, 2011


Regular Cash

Mar 9, 2011

Mar 22, 2011

Mar 24, 2011

Apr 11, 2011


Regular Cash

Dec 8, 2010

Dec 21, 2010

Dec 23, 2010

Jan 10, 2011


Regular Cash

Sep 10, 2010

Sep 22, 2010

Sep 24, 2010

Oct 8, 2010


Regular Cash

Jun 9, 2010

June 22, 2010

June 24, 2010

Jul 9, 2010


Regular Cash

Mar 11, 2010

Mar 23, 2010

Mar 25, 2010

Apr 9, 2010


Regular Cash

Dec 9, 2009

Dec 23, 2009

Dec 28, 2009

Jan 11, 2010


Regular Cash

Sep 15, 2009

Sep 24, 2009

Sep 28, 2009

Oct 9, 2009


Regular Cash

Jun 10, 2009

Jun 22, 2009

Jun 24, 2009

Jul 10, 2009


Regular Cash

Mar 12, 2009

Mar 23, 2009

Mar 25, 2009

Apr 9, 2009


Regular Cash

Dec 16, 2008

Dec 23, 2008

Dec 26, 2008

Jan 9, 2009


Regular Cash

Aug 29, 2008

Sep 11, 2008

Sep 15, 2008

Oct 10, 2008


Regular Cash

Jun 18, 2008

Jun 26, 2008

Jun 30, 2008

Jul 10, 2008


Regular Cash

It looks like the company has settled in to a nice little pattern of raising the dividend every four quarters. I expect that we will get three more quarters of $.77 per share, and then management will give us another increase.

I tend to prefer dividends over share repurchases for a couple reasons. First, since I hold all my stocks in tax advantaged accounts, repurchases do not have a tax advantage over dividends for me. Receiving the money as dividends gives me the control to decide whether to reinvest them or not (I almost always do).

The second reason is that many companies all too often time buybacks poorly. Companies tend to buy shares of their own stock aggressively when economic times are good and prices are at all time highs. When the economy stumbles and stocks are a bargain, buybacks dry up. This is exactly the opposite of what companies should be doing if they want to benefit shareholders.

On the other hand, companies in the US cut dividends only under the most dire of circumstances, because US investors punish the stock of companies that cut dividends. I don’t think that this is necessarily a good thing, as there are certainly companies that would benefit from dividend flexibility, but it is the way things are, and all I can do is try to use it to my advantage. I know that as long as I invest in dividend paying companies that are strong enough to continue paying dividends when stock prices are at a cyclical bottom, those dividends will be reinvested at advantageous prices. PM, however, has also managed to avoid falling into the poorly timed buyback trap. Since May 2008, it has spent $20.3 Billion on buybacks, at an average price of $50.81. I bought shares within the past year at just over $56, so I certainly think that management got a good deal on their purchases.

PM also has the ability to borrow very cheaply. The company recently issued $1.25 Billion in debt due May, 2016, that carries an interest rate of 2.5%. The proceeds of the debt were used for working capital, stock repurchases, debt refinancing, and general corporate purposes. I don’t use leverage in my investment portfolio, but if I could borrow at 2.5% for four years to purchase something with a 4.3% yield, I would likely re-evaluate that policy. I am glad that PM’s management has done so on my behalf.

With a current TTM P/E ratio of 15.21, I don’t think that PM is a screaming bargain, but great businesses rarely are. I think it is a great company at a fair price, and it is certainly a stock that investors should keep on their radar.

Something important to keep in mind is that PM derived 30% ($2.506B) of its $8.362B 3Q 2011 revenues from the European Union. Last week it seemed that the market was feeling positive about the Italian and Greek situations being resolved, but that sentiment has seemingly changed on a daily basis. I don’t view the Europe situation as harmful to PM’s long term business prospects, but should the troubles in Europe create any volatility to the downside for PM, it might provide a nice entry point for someone looking to establish a position.

If you are a retiree looking for income, there aren’t many things that will pay you 4.3% right now. I also expect that dividend to continue to grow at a rate far exceeding that of the inflation rate. If you are a younger investor, I recommend buying PM in a Roth IRA and reinvesting the dividends. In 10 years, I expect that you will be very happy with your purchase.

Disclosure: I am long MO, PM, AAPL.

Source: Philip Morris: Dividend Income With Excellent Growth Potential