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Governments around the world are ramping up regulations on tobacco products. In light of this, are tobacco companies the best stocks for investors today? Do they compensate investors for the industry-specific risk that they face?

As it turns out, there are better stocks out there for dividend investors. It appears that cigarette companies are getting income investors hooked on unsustainably high dividends. The long-term hazards facing these stocks and their precarious dividend policies suggest that they are not the best stocks to buy today by any stretch of the imagination. Alternative high dividend-paying stocks are suggested to help income investors kick the cigarette stock habit.

Australian Tobacco Regulations

There was a time when glitzy logos would decorate cigarette packaging and when tobacco marketing materials would focus on pleasurable puffs. This is changing in Australia where tobacco companies are required to place images of cancer victims and gangrenous limbs on cigarette packs.

A manufacturing ban on Australia's $10 billion tobacco industry has been in effect since the start of October. To comply with new government standards, there must be images and health warnings covering seventy five percent of the front of cigarette packs. The new pack will display disgusting images including tongue cancer, a skeletal man dying of lung cancer, or an infected foot. Additional warnings have to cover the sides of the packages and ninety per cent of the back.

Health officials are hopeful new cigarette packages will dissuade more consumers from smoking. After most of the packaging is not covered in cautionary warnings, the remainder is required to be very plain. According to the state law, there must not be any trademarks and all the product names have to be in Lucida Sans font and that the background must be a greenish-brown color. State officials will be on the lookout for deviation from these regulations.

Government officials hope that the new packaging will curtail the recruitment of young people. Australia's health minister Tanya Plibersek said, "Young people are the ones most affected by the packaging and by the advertising, and no parent wants their kid to start smoking."

Countries including the United Kingdom, Turkey, New Zealand, India, and Russia expressed interest in more severe plain packaging rules. Margaret Chan, the World Health director-general said, "With so many countries lined up to ride on Australia's coattails, what we hope to see is a domino effect for the good of public health."

Tobacco Warning

Are the stifling Australian tobacco regulations a forewarning of the future in other countries? Is a preview of the global future of tobacco products or are Australian-derived extrapolations to the globe as meaningless predictive as watching Mad Max?

As sane human beings we should recognize that there is no way to predict the future, and that the possibility of such hard impositions on packaging and advertising could manifest in any country. Since this risk could become reality, tobacco stocks should be much, much cheaper than other stocks.

Consider the following cigarette and non-cigarette companies:

Ticker

Company

Industry

P/E

P/S

P/B

P/FCF

Div Yield

Payout Ratio

VGR

Vector Group

Cigarettes

69

1.27

9.20%

6.14

PM

Philip Morris

Cigarettes

18.15

1.99

47.89

3.72%

0.61

RAI

Reynolds American

Cigarettes

17.02

2.89

4.12

5.50%

0.89

MO

Altria Group

Cigarettes

15.52

2.8

15.96

5.25%

0.76

LO

Lorillard

Cigarettes

14.31

2.34

93.77

5.33%

0.70

HI

Hillenbrand

Diversified Machinery

11.19

1.21

2.38

16.2

4.14%

0.46

GCI

Gannett

Publishing - Newspapers

10.59

0.8

1.75

7.68

4.47%

0.33

GME

GameStop

Electronics Stores

10.21

0.33

1.07

5.86

4.17%

0.13

CLF

Cliffs Natural Resources

Steel & Iron

4.16

0.89

0.94

35.3

6.00%

0.15

It looks like cigarette companies are using high dividends fueled by unsustainably high dividend payout rates to keep income investors hooked. These dividends will not last forever since payout ratios above 0.60 don't leave margin for error if times get lean or as governments continue to crack down on your products.

Fortunately there are alternative stocks which offer superior valuation metrics. Each of the alternative stocks on this list, Hillenbrand, Gannett, GameStop, and Cliffs Natural Resources are trading at lower valuations than the listed cigarette companies. They also offer high dividend yields above 4% with sustainable payout ratios. Think of them as dividend patches to help you quit the tobacco dividend habit.

Disclaimer: This article was written to provide investor information and education, and should not be construed as a guarantee or investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing. Moreover, this research does NOT constitute a guarantee.

Source: Kick The Tobacco Dividend Habit