The discussion about many dividend stocks having gotten quite pricey over the past few years thanks to record low rates has become more widespread recently. Maybe that's because investors interested in generating income at reasonable prices are having a more difficult time finding what they're looking for of late.
Dividend growth investors should make sure the companies they invest in achieve annual dividend growth that is at least a couple hundred basis points above inflation (let's say about 5%-6% for annual dividend growth; I don't think government CPI figures of 2% are particularly accurate). Of course, the capital appreciation component of dividend growth investing is just as important. Altria's (MO) stock price appears set for stagnation in the foreseeable future.
Altria has been a clear favorite among the dividend investing crowd, thanks to its yield (which, until recently, was typically above 5%), low beta, and steady history of capital appreciation.
My main concerns regarding investing in Altria at the present time are as follows:
- Valuation: Buying something at an inappropriate premium is never savvy. As is the case with many stocks attractive to income investors, Altria is trading above 20 times trailing earnings. While price-to-earnings multiples are often given too much credit, it's particularly apparent that for a company in the tobacco industry with poor growth prospects, Altria should not be trading at such a premium multiple relative to the broader market. Here is the four-year EPS history, beginning in 2008 through 2011: $1.48, $1.54, $1.87, and $1.64. Trading at $15.06 at the end of 2008, Altria was priced at 6 times earnings. Since then, shares are up about 130%, though earnings are up only 11%. The success of Altria's stock over the last several years seems to be a result of extremely depressed expectations from 2008, and a subsequent multiple expansion, rather than an improvement in business operations. Investors getting in at today's prices are set up for very small levels of earnings growth, and therefore capital appreciation.
- Future and Stability of Dividend Growth: Based on 2011's free cash flow and dividend payments, Altria had a payout ratio of 93%. This is particularly high when you consider that Altria has a high debt load of almost $14 billion, which requires interest payments. Additionally, an inability to meaningfully grow cash flow will mean slower, if not stagnant, dividend growth -- unless Altria issues debt to maintain its growth.
Altria is simply not worth the 4.80% dividend yield. You want to make sure the companies you invest in have exceptional balance sheets and solid growth prospects over a long-term horizon. Altria offers neither. While Altria is nowhere near cutting its dividend in the short term, it is plausible that 10 years out its share price could still be under $40, its dividend growth underperforming inflation, and volatility in the stock at a higher level. The risks involved with an investment in Altria make it an inappropriate stock for dividend growth investors.