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PM: The Gift The Market Keeps Giving

September 11th, 2013 Leave a comment Go to comments

The S&P500 is up nearly 20% YTD, after factoring in dividends. Looking at my portfolio, I noticed that Philip Morris (PM) was a few days ago flat for the year, not including dividends. After adding to my position at the end of last year, the question is, did I make a bad choice here? I could have simply invested in the index fund. There are also countless other stocks out there that are up 30%, 40% or more. This is what happens when the market does well, many stocks go up a lot more than the average.

It seems that some stocks are being bought simply because somebody rang a bell to buy stocks.

This is the time when you need to suck it up and stick to your investing plan because when the market runs away from you it can seem illogical to hold stocks that don’t move.

So, last week, I bought more Philip Morris (PM) at close to the same price I bought it last year: $84. The logic for doing this is as follows. It is better to buy earnings than to buy stocks that go up just because they do. Say you can make a case to increase your earnings from an investment 15% in a year, through a combination of stock buybacks, dividends and company operational performance.

If you can get this kind of return, you want lower stock prices, not higher stock prices. A lower stock price gets you a higher percentage share of ownership and will in the long run increase your returns.

PM: Current Wall Street Dog

Consider Philip Morris (PM).

It hasn’t work out that well for PM so far this year. First, the earnings of PM are getting hit due to currency conversion losses. PM reports it’s earnings in dollars but collects revenue in currencies around the world. This must be a major headache, but don’t let this distract you from the actual earnings performance in each local currency which turns out looks pretty good. Also, the company has taken a few hits related to inventory timing/control after major tax increases were announced and implemented in some key markets. This disruption did hurt the short term performance in the last quarter.

At the start of the year, you would have been on track to collect a 4% dividend. Yesterday, PM announced a nearly 11% increase in the dividend. What this means is that your earnings would increase nearly 15% this year, if you reinvested the dividend.

Of course you don’t actually get the extra 11% unless the stock price goes up. If the market felt the same way about these earnings as they did 6 months a go, a constant P/E would imply that the stock price would increase. However, PM is likely grabbing some forward earnings here by increasing the payout ratio temporarily. As I talked about here previously, PM temporarily increased its targeted payout ratio during the financial crisis. This case will likely work out the same way as before: the earnings will catch up in the future and the payout ratio will be restored back to the 65% target.

The fact that the price is flat for the year means that you can buy the stock cheaper than last year. The forward dividend yield has increased from 4% to 4.5%. This is a gift that the market is giving you since you can buy more earnings for less money, just like a sale on bread at the super market.




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