Tobacco giant Altria (NYSE:MO) has for years been known as a king among dividend payers. There's good reason for this, of course, since Altria's track record is nearly impossible to match. Altria has increased its dividend 47 times in the last 44 years.
Because of the amazing power of compound interest, Altria has been one of the very best stocks to own over this time period. In fact, noted economist Jeremy Siegel calculated in his book, "The Future for Investors", that Altria was the single best stock to own from 1925 to 2003.
The biggest reason for this is Altria's dividend. Not only does Altria provide a high yield, but it grows its dividend each year.
The magic formula: High yield plus dividend growth
Altria is a diverse business. Its flagship Marlboro cigarettes are complemented by a wine business, smokeless chewing tobacco brands such as Copenhagen and Skoal, as well as a sizable stake in brewer SABMiller (OTCPK:SBMRF), that all contribute to earnings.
These businesses produce reliable cash flow, and require only modest capital expenditures. This results in high returns on invested capital that allow Altria to pay such a nice dividend to shareholders, and keep room for dividend increases every year.
At this point, many investors frequently cite the risks associated with tobacco companies. The most alarming one is litigation risk. And it's true that over the course of the past few decades, this risk has served as an overhang on Altria's valuation.
Litigation risk in the tobacco industry recently reared its ugly head once again when Reynolds American (NYSE:RAI) subsidiary R.J. Reynolds was hit with lawsuit in which a jury ordered the maker of Camel and Winston cigarettes to pay an astounding $23.6 billion to an individual. While this particular number seems absurd and will likely be drastically reduced, these types of lawsuits are a constant threat to tobacco companies.
But it's also true that these risks have actually served to compound investors' wealth even faster. That's because a lower valuation allows investors to reinvest dividends at better prices, enhancing the snowball effect that is compounding interest. Altria currently trades for 15 times 2015 earnings estimates, which is about on par with the S&P 500.
A clear and transparent dividend policy
One of the best aspects of owning Altria is the lack of guessing that goes into Altria's dividend announcements. Every year around late August, Altria raises its dividend. And, whereas with many other companies you have no idea how much they might increase the payout, Altria provides investors with all the tools you need.
That's because Altria consistently maintains a target payout ratio of 80% of adjusted earnings. This removes the potential for surprises. This year, Altria expects to generate adjusted earnings in a range of $2.54 per share to $2.59 per share. This would represent solid 7% to 9% growth versus 2013.
If Altria hits the midpoint of its guidance, an 80% payout ratio would mean a future dividend rate of $2.05 per share. Altria's current annualized dividend totals $1.92 per share, so if all goes according to plan, investors should be treated to at least a 6.7% dividend increase in a few weeks.
How much will Altria increase its dividend?
Plus, there's the potential that Altria may increase it slightly higher than that, if management believes it can reach the high end of its earnings forecast.
I believe that this is a likely scenario. Adjusted earnings per share are up 5% through the first half of the year, and Altria's aggressive share buybacks should provide a few more percentage points of growth. After reporting second-quarter earnings, Altria announced a new $1 billion share repurchase authorization that should keep boost EPS growth.
That's why I'm betting Altria ups its dividend to $0.52 per share, or $2.08 per share annualized, which it will do at the end of this month. This would represent an 8% dividend increase, and keep the wheels of compounding wealth spinning.
Disclosure: The author is long MO. 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.
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