Does Dividend-Paying IBM or Altria Deserve a Berth in Your Portfolio?

There's a compelling case for either stock as a long-term holding.

Jun 30, 2014 at 5:47PM

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Source: IBM.

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some large value stocks to your portfolio but don't have the time or expertise to hand-pick a few, the Vanguard Value ETF (NYSEMKT:VTV) could save you a lot of trouble. Instead of trying to figure out which stocks will perform best, you can use this exchange-traded fund to invest in lots of large value stocks simultaneously.

Why focus on large value stocks? Well, one way to up your chances of getting great results investing is to focus not only on established companies but also ones that are undervalued, offering a margin of safety. This ETF favors value. It's also full of large-cap stocks, which, in general, are more reliable than smaller, younger, upstarts. They've done a lot of things right in order to have become large.

The ETF's basics
ETFs often have lower expense ratios than their mutual fund cousins. This large value stocks ETF sports a very low expense ratio -- an annual fee -- of 0.09%. It has roughly matched the S&P 500 over the past five and 10 years. It's fair to expect more, but every time period will offer different results, and focusing on large value stocks is a promising investing approach. This ETF yields about 2%.

On your own you might not have selected International Business Machines Corp. (NYSE:IBM) or Altria Group Inc (NYSE:MO) as large value stocks for your portfolio, but this ETF included them among its 300-some holdings.

A closer look at International Business Machines
IBM is still a technology giant, with annual revenue near $100 billion, but it has been struggling. Revenue and free cash flow have recently been below levels of a few years ago, but earnings and profit margins generally have been growing. That's because IBM has been transforming itself from a hardware powerhouse into a significant player in cloud computing and business analytics, which can deliver higher profit margins. Think, for example, of its artificial-intelligence computer system Watson, in which it has invested more than $1 billion. The technology can analyze vast quantities of data and can also learn, and it serves as a competitive advantage, differentiating IBM from rivals.

Big Blue's shedding of hardware businesses has directly reduced its top and bottom lines, but it has also helped boost profit margins considerably, with net margin surging from single digits a decade or so ago to around 16% recently. CEO Ginni Rometty isn't done, either. IBM is reportedly in talks to sell its chipmaking operations to privately held GlobalFoundries. (Note that IBM has retained its flagship mainframe business, which is threatened by cloud computing to some degree but also offers greater security and reliability to those companies that critically need it.)

It's true that IBM isn't firing on all cylinders now, and it faces strong competition (none other than Microsoft is looking to challenge Watson), but it has deep pockets and valuable technologies, and it has been investing in future growth. In cloud computing, for example, it holds more than 1,500 patents and has made about 15 acquisitions. IBM is the king of patents, actually, with more than 6,800 awarded last year and more than $1 billion generated annually from royalties.

For patient believers, IBM stock offers a dividend yield of about 2.4%, and with a forward P/E ratio of nine, its stock is intriguing.

A closer look at Altria Group (and Philip Morris International)
There are a lot of reasons to pass up investing in the tobacco giant Altria: rising taxes on tobacco, increased regulations, competition from discount cigarettes, and a shrinking smoker base. These have led plenty of people to favor the company's nondomestic counterpart, Philip Morris International (NYSE:PM), as it's viewed as facing fewer challenges and offering more growth potential, as it operates in emerging markets, where growing middle classes will smoke more cigarettes. However, Philip Morris is also increasingly challenged by taxes and regulations in some markets -- in Uruguay, for instance, the company is actually suing the country due to antismoking legislation passed there. And while Philip Morris' rivals have enjoyed growth in their discount and mid-market brands, it's focused primarily on its high-priced premium brand, Marlboro.

This has led the company to lower guidance recently, citing, among other factors, currency fluctuations and black-market tobacco. Bulls applaud Philip Morris' big share buybacks (possibly approaching $4 billion) that boost EPS, but investors should prefer to see EPS growing due to top-line growth, not buybacks.

All is not lost for Philip Morris, though, and bulls are hopeful about Altria, as well, due to the strong growth of electronic cigarettes ("e-cigs"). And beyond that, Altria has some other advantages over Philip Morris, such as considerable nontobacco operations. Its businesses include not just regular cigarettes, but smokeless tobacco offerings, cigars, wine, and a sizable stake in the SABMiller beer company. Altria has also been growing its business rather consistently despite the significant headwinds mentioned above -- by cost-cutting, price-hiking, refinancing its hefty debt load, and innovating.

Altria's first quarter featured declining cigarette volume, but increases in smokeless tobacco sales and Marlboro market share. Adjusted diluted EPS rose 5.6%, thanks in part to rising profit margins.

Altria stock yields 4.5%, and management has been regularly hiking that significantly for decades. The company boasts net margins well above 20% and more than $4 billion in annual free cash flow. With its P/E ratio of 19 above its five-year average, it doesn't appear to be a screaming bargain, but it still warrants consideration as a long-term income-generator.

The big picture
It makes sense to consider adding some large value stocks to your portfolio. You can do so easily via an ETF. Alternatively, you might simply investigate an ETF focused on large value stocks and then cherry-pick from its holdings after doing some research on your own.

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Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns shares of Microsoft. The Motley Fool owns shares of International Business Machines and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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