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Buying More Altria

September 16th, 2013 Leave a comment Go to comments

Let’s take a look at the performance of Philip Morris (PM) compared to its former parent Altria (MO) over the past 5 years. Which one do you think has performed better? Which one should have performed better?

The answer gets to the heart of how dividend growth investing works and why you should really consider investment performance on what actually happens versus what you think should happen. After being spun out from its parent, Philip Morris has the possibility of better prospects as an investment because it competes in more diversified markets that are still developing and growing.

The thinking is that PM can grow faster due to the familiar growth story: selling additional units at a high margin gets you more profits than the first units¬† because you have already paid for most of your overhead. Tobacco companies have very high margins, over 40%. There aren’t too many businesses that have these margins.

It’s not news that on the domestic front that tobacco unit sales are declining over time. This doesn’t sound like a place you would want to be. The international markets are where you want to be.

The whole problem with this thesis is that you need to consider valuation. If you pay too much for the company with better prospects, you may not actually get a better return. Returns are what you want, who cares how you get there?

Performance Since 2008

Let’s compare the performance of the two companies since PM was spunoff. Altria (MO) spunoff Philip Morris in 2008. This what has happened since then.

Stock Price Chg 69% 86%
Dividend Increase 66% 104%
2008 Yield 5.5% 3.7%
2013 Yield 5.5% 4.3%
2008-2013 Dividend Growth 11% 14%
2008-2013 Total Return* 16.1% 15.7%

*average annual return, dividends reinvested.

The first thing to notice is that there is no bad news here. Either company has been a great investment, the noteworthy news is that the total return for MO is actually a little better than PM over the past 5 years. By the first two metrics, PM has better price appreciation and better dividend growth. How could it under perform?

It’s all about Math, and Company Performance.

First, MO is performing very well in direct contradiction to its expected prospects. The reasons are many: lower than expected settlement payouts, pricing power that counteracts the volume declines, huge buybacks, cost management, plus good performance in its other businesses that are outside its core cigarette products.

Despite all this good news, the fact remains that PM is increasing its earnings and dividend faster.

The second point about math. MO can outperform PM because its payout ratio is higher, dividend yield is higher and when you reinvest the dividends you are buying a cheaper company on an earnings basis.

When you reinvest more money sooner in a cheaper stock, it will beat out the lower yielding/higher growth stock for some time. Over the longer term, the higher dividend growth of PM will outperform but it’s gonna take time for it to catch up. The return for MO has been phenomenal when you add the nearly 6% yield to its average dividend increase of 10%/year. PM has a better return profile, with a 4% yield and a 14% average yearly dividend increase but it’s not that much better. It will take some time for it to really start to outperform.

What To Do Now

When you compare the performance of both companies, you can see that PM is clearly lagging. Its dividend is up over 100% but the stock price is up only 86%. The same metrics for MO are up 66% and 69% respectively.

If you buy PM now, you will get a better price than one would expect based upon its history. Even so, you will be faced with the possibility that you might under perform MO in the near term. Over the long term though (10+ years) your investment today should outperform.

I’ve already mentioned recently that I added to PM. Now I’m adding to MO as well due to some recent news.

MO announced higher guidance due to lower than expected settlement payments for 2013.¬† Based on the average earnings anticipated, earnings should increase over 10% from here to $2.60/share in 2014. At an 80% payout ratio, this suggests a future dividend next year of at least $2.08, or a 10% increase. At today’s price of $35/share this would suggest a forward yield of 6%.

Looks like the excellent performance of MO will continue to roll on.


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