The Most Promising Dividends in Tobacco

Dividend payers deserve a berth in any long-term stock portfolio. But seemingly attractive dividend yields are not always as fetching as they may appear. Let's see which companies in the tobacco industry offer the most promising dividends.

Yields and growth rates and payout ratios, oh my!
Before we get to those companies, though, you should understand just why you'd want to own dividend payers. These stocks can contribute a huge chunk of growth to your portfolio in good times, and bolster it during market downturns.

As my colleague Matt Koppenheffer has noted: "Between 2000 and 2009, the average dividend-adjusted return on stocks with market caps above $5 billion and a trailing yield of 2.5% or better was a whopping 114%. Compare that to a 19% drop for the S&P 500."

When hunting for promising dividend payers, unsophisticated investors will often just look for the highest yields they can find. While these stocks will indeed pay out the most, the yield figures apply only for the current year. Extremely steep dividend yields can be precarious, and even solid ones are vulnerable to dividend cuts.

When evaluating a company's attractiveness in terms of its dividend, it's important to examine at least three factors:

  1. The current yield
  2. The dividend growth
  3. The payout ratio

If a company has a middling dividend yield, but a history of increasing its payment substantially from year to year, it deserves extra consideration. A $3 dividend can become $7.80 in 10 years, if it grows at 10% annually. (It will top $20 after 20 years.) Thus, a 3% yield today may be more attractive than a 4% one, if the 3% company is rapidly increasing that dividend.

Next, consider the company's payout ratio, which reflects what percentage of income the company is spending on its dividend. In general, the lower the number, the better. A low payout ratio means there's plenty of room for generous dividend increases. It also means that much of the company's income remains in its hands, giving it a lot of flexibility. That money can fund the business's expansion, pay off debt, buy back shares, or even buy other companies. A steep payout ratio reflects little flexibility for the company, less room for dividend growth, and a stronger chance that if the company falls on hard times, it will have to reduce its dividend.

Peering into tobacco
Below, I've compiled some of the major dividend-paying players in tobacco (and a few smaller outfits), ranked according to their dividend yields:

Company

Recent Yield

5-Year Avg. Annual Div. Growth Rate

Payout Ratio

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Vector Group

8.5%

3.0%

220%

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Altria (NYSE: MO  )

6.1%

9.4%*

93%

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Reynolds American (NYSE: RAI  )

5.7%

9.1%

87%

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Universal (NYSE: UVV  )

4.9%

2.1%

37%

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Lorillard (NYSE: LO  )

4.8%

12.1%*

66%

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Philip Morris International (NYSE: PM  )

3.8%

11.6%*

59%

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British American Tobacco

2.8%

15.0%

76%

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Source: Motley Fool CAPS. *Past three years.

If you focus on dividend yield alone, you might end up with Vector Group, but with its payout ratio of 220%, it's not necessarily your best bet. Its growth rate is meager, too.

Instead, let's focus on the dividend growth rate first, where British American Tobacco and Lorillard lead the way. Their growth rates are so steep, though, that they may be hard to maintain for long. Though with their payout ratios well below 100%, that's not an immediate concern.

You may notice, too, that some players in the industry, such as Star Scientific (Nasdaq: CIGX  ) and Alliance One International (NYSE: AOI  ) , aren't on the list. That's because smaller, fast-growing companies often prefer to plow any excess cash into further growth, rather than pay it out to shareholders.

Just right
As I see it, among the companies above, Philip Morris International and Lorillard offer the best combination of dividend traits, sporting some solid income now and a good chance of strong dividend growth in the future. Altria is worth considering, too, although its payout ratio is somewhat higher. Its dividend cut in 2008 is misleading because it followed its spinoff of Philip Morris International. And while Reynolds American also has a payout ratio on the steep side, its current yield is rather generous and growing at a good clip -- for now.

Of course, as with all stocks, you'll want to look into more than just a company's dividend situation before making a purchase decision. Still, these stocks' compelling dividends make them great places to start your search, particularly if you're excited by the prospects for this industry.

Do your portfolio a favor. Don't ignore the growth you can gain from powerful dividend payers.

To get more ideas for great dividend-paying stocks, read about "13 High-Yielding Stocks to Buy Today."

Longtime Fool contributor Selena Maranjian holds no position in any company mentioned. Click hereto see her holdings and a short bio. The Motley Fool owns shares of Altria Group and Philip Morris International. Motley Fool newsletter services have recommended buying shares of Philip Morris International. 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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