Will Philip Morris International's Dividends Last?

Whether you're a beginning investor or a near-retiree, the importance of purchasing stocks that pay dividends cannot be overstated. Not only do companies that have quarterly or annual payouts provide you with a steady stream of income, they also have the potential for capital appreciation. Simply put, dividend stocks can you give your portfolio what almost no other investment can -- both income and growth.

At The Motley Fool, we're avid fans of dividends -- and not just because we like that steady stream of cash. Studies have shown that from 1972 to 2006, stocks in the S&P 500 that don't pay dividends have earned an average annual return of 4.1%; dividend stocks, however, have averaged a whopping 10.1% per year. That is an incredible difference -- one that you'd be crazy to not take advantage of!

But investing in dividends can be dangerous -- companies can cut, slash, or suspend dividends at any time, often without notice. Fortunately, there are several warnings signs that may alert you, and these red flags could be the crucial factor in determining whether or not a company is likely to continue paying its dividend. Today, let's drill beneath the surface and check out Philip Morris International (NYSE: PM  ) .

What's on the surface?
Philip Morris International, which operates in the tobacco industry, currently pays a dividend of 4.4%. That's certainly nothing to sneeze at, as the average dividend payer in the S&P 500, in 2009, sported a yield of 2%.

But what's more important than the dividend itself is Philip Morris International's ability to keep that that cash rolling. The first thing to look at is the company's reported dividends versus its reported earnings. If you happen to see dividend payments that are growing faster than earnings per share, it may be an initial signal that something just isn't right. Check out the graph below for details of the past five years:

Clearly, there doesn't seem to be a problem here. Philip Morris International has been able to boost its earnings at an adequate pace and keep its dividends in check at the same time.

The more secure, the better
One of the most common metrics that investors use to judge the safety of a dividend is the payout ratio. This number tells you what percentage of net income is paid out to investors in the form of a dividend. Normally, anything above 50% is cause to look a bit further. According to the most recent data, Philip Morris International's payout ratio is 62.1%. While this payout ratio isn't necessarily outrageous, it would serve us well to dig a bit deeper. Let's take a look at Philip Morris International's free cash flow to see if there are enough greenbacks to support that 62.1% payout ratio.

Free cash flow -- all the cash left over after subtracting out capital expenditures -- is used by firms to make acquisitions, develop new products, and of course, pay dividends! We can use a simple metric called the cash flow coverage ratio, which is cash per share divided by dividends per share. Normally, anything above 1.2 should make you feel comfortable; anything less, and you may have a problem on your hands. Philip Morris International's coverage ratio is 1.89, which is more than enough cash on hand to keep pumping out that 4.4% yield. Barring any unforeseen circumstances, there really shouldn't be any major problems moving forward.

Either way, it's always beneficial to compare an investment with its most immediate competitors, so in the chart below, I've included the above metrics with that of Philip Morris International's closest competitors and other consumer-goods companies. In addition, I've included the five-year dividend growth rate, which is also a very important indicator. If Philip Morris International can illustrate that it's grown dividends over the past five years then there's a good chance that it will continue to put shareholders first in the future. Check out how Philip Morris International stacks up below:

Company

Dividend

Yield

Payout

Ratio

Coverage Ratio

5-Year Compounded Dividend Growth Rate

Philip Morris International

4.4%

62.1%

1.89

N/A

Coca-Cola

3.2%

53%

1.76

9.9%

PepsiCo

2.9%

46.1%

1.85

14%

British American Tobacco (NYSE: BTI  )

4.5%

71.3%

1.73

19.4%

Altria (NYSE: MO  )

6.1%

81%

1.17

-13.9%

Imperial Tobacco (LSE: IMT  )

3.9%

49.3%

4.08

8.2%

The Foolish bottom line
Only you can decide what numbers you're comfortable with in the end; sometimes a higher yield and a higher reward means additional risk. However, in this situation, Philip Morris International's payout ratio seems to be above the peer average, which means if you're a prudent investor, you may want to look elsewhere for the most secure payment possible. Although, with a high yield and a sufficient coverage ratio, I wouldn't be too worried about this stock. The bottom line, however, is to make sure that with anything -- whether it be a dividend, a share repurchase, or an ordinary earnings report -- you do your own due diligence. Looking at all of the numbers in the proper context is just the best place to start.

Jordan DiPietro owns no shares. Coca-Cola is a Motley Fool Inside Value choice. Philip Morris International is a Motley Fool Global Gains selection. Coca-Cola and PepsiCo are Motley Fool Income Investor recommendations. Motley Fool Options has recommended a diagonal call position on PepsiCo. The Fool owns shares of Altria Group and Coca-Cola. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 19, 2010, at 10:15 PM, prginww wrote:

    PMI as it's known in the industry has a long smooth way to go before it hits a speed bump. Admittedly, in developed markets it will be in flat or slightly upward momentum but it is poised for growth in the "small" markets like China, India and is also in a good financial position in Japan where an up and coming price increase should benefit a bottom line which is already in the top three of the company. Africa has yet to be dealt with and in recessions, tobacco always does well, look and superpose economic data with PM stock and share positioning.

  • Report this Comment On August 19, 2010, at 11:33 PM, rwwww wrote:

    Altria (NYSE: MO)

    6.1%

    81%

    1.17

    -13.9%

    The -13.9% (5 Year Compound Dividend Rate) is MISLEADING in that MO spun off PM on 3/30/2008.

    You'd have to add both MO + PM to get a real number.

  • Report this Comment On August 20, 2010, at 5:07 PM, carload wrote:

    I am becoming disgusted with these formulaic series that plug in numbers but absolutely no thought.

    rwwww's point above is a perfect example.

    Others in the current series's all illustrate the same lack of effort.

    Comparing companies with vastly different business models against each other is also seen in most of these 'series' articles, at least this one doesn't have a glaring error in that area.

    Come on Fool, if you're going to write about companies, at least put a LITTLE research into their background and their business models, instead of just churning out articles.

    Quality over quantity, please!

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