1 of the Best Places for High Dividend Yields

One industry continues to offer some of the highest dividends in the market, and it could well be a growth story with its newest products.

May 12, 2014 at 2:52PM

Despite the overhang of potential Food and Drug Administration regulation of e-cigarettes, shares of the major tobacco companies continue to move higher. After all, the industry has survived radical regulation changes before. If the FDA does manage to regulate e-cigarettes, it just means that manufacturers will have to get FDA approval for their products and disclose the items used in e-cigarettes.

The e-cig market as it stands
Lorillard (NYSE:LO) already owns 45% of the e-cigarette market in U.S. convenience-store sales. However, Altria Group (NYSE:MO) and Reynolds American (NYSE:RAI) are looking to break into the market this summer. Altria is bringing to market its MarkTen e-cigarette. With Reynolds American, it's bringing to market its own developed Vuse brand.

As mentioned, Lorillard is already the leader in the market; it bought up the blu eCig brand in 2012. This allowed the company to get ahead of the curve and gave Lorillard a first-mover advantage. It purchased blu eCig for just around $135 billion, and last year the brand brought in $230 million.

But it's not all about e-cigs
Lorillard still has the No. 1 menthol brand, Newport. The FDA ban on menthol cigarettes never came to fruition, and Lorillard has turned out to be a great performer for shareholders. Reynolds American has the popular American Snuff brand. Its current smokeless-tobacco sales are helping to offset the decline in cigarette sales, hence Reynolds American's push toward e-cigs. The other thing impacting Reynolds American is that consumers can easily trade down from its premium brands, including Camel, Pall Mall, and Natural American Spirit.

However, the good news for Reynolds American is that Lorillard might be interested in purchasing the company. The news surfaced in March, with the most recent development being that Lorillard might be willing to pay as much as $80 a share for Reynolds American. But the risk is there are some hurdles related to antitrust. With Lorillard already owning more than 40% of the U.S. menthol market share, the merger would likely force Reynolds American to divest its menthol brands.

Then there's Altria, which owns the best-selling brand in the U.S.--Marlboro. The company owns more than 50% of the U.S. tobacco market; as a matter of fact, Lorillard and Reynolds American combined would still have less market share than Altria. Lorillard's market share is slightly less than 15%, and Reynolds American's is 25%.

How shares stack up
One of the big lures for investors is that these tobacco companies offer above-average dividend yields. The S&P 500 has an average dividend yield of 2%. All three of the dividend yields for the major tobacco companies are above 4.5%. They all also trade with a P/E ratio of 15 based on next year's earnings estimates.

One of the big differences between the companies is that Lorillard has been an absolute machine when it comes to reducing its outstanding shares. Over the last five years, Lorillard has lowered its shares outstanding by 27%, while Altria and Reynolds American have lowered theirs by 4% and 8%, respectively.

Analysts also expect Lorillard to grow earnings at an annualized rate that's nearly 4 percentage points higher than Altria and Reynolds American for the next five years. Lorillard expects earnings to grow at an annualized 10.8%, while Altria and Reynolds American are each expected to grow at 7.4%.

Bottom line
All three of these tobacco stocks pay impressive dividend yields and trade relatively in line with each other on a P/E ratio basis. But the big difference is that Lorillard is growing earnings at a much faster rate, thanks to its strong buyback strategy. Lorillard is also already the leader in the fast growing e-cigarette market. For investors looking to gain exposure to the tobacco market, Lorillard is worth a closer look.

Top dividend stocks for the next decade
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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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