Your Simple Guide to Tobacco Stocks

Tobacco stocks are among the most controversial on the market. On one hand, tobacco companies merely provide a common consumer good, appealing to customers' demand for the products they make. Yet the negative health impacts of smoking make some investors vehemently opposed to the businesses that produce cigarettes. That has prompted a trend among some socially conscious investors of divesting their portfolios of any exposure to tobacco, but it has also pushed tobacco giants themselves to seek out alternatives to traditional cigarettes that could potentially have reduced risks.

The tobacco industry includes a number of areas, including cigarettes, cigars, smokeless tobacco, and cigarette alternatives like e-cigarettes and heated-tobacco products. A few big companies control substantial market share in the U.S., and just a handful of players have big positions globally. By understanding the entire industry, you can make a better decision about whether tobacco stocks are appropriate for your portfolio.

Image source: Getty Images.

Top tobacco stocks

Data source: Yahoo! Finance.

The big U.S. players

If you want exposure to the U.S. market, then British American Tobacco and Altria Group are the two natural places to start. These two companies command a near-total grip over the premium-cigarette market in the U.S.: Altria controls the Marlboro brand, while British American has taken all of the brands that were previously owned by Reynolds American and Lorillard, including Newport, Camel, and Pall Mall.

Increasingly, Altria and British American have expanded their focus to go beyond being pure-play cigarette businesses. Altria has smokeless-tobacco products and also has its Nu Mark division giving it exposure to a wide variety of reduced-risk products. Altria's partnership with Philip Morris International also gives it the rights to market Philip Morris' iQOS heated-tobacco system within the U.S. Meanwhile, British American has used the Reynolds Vuse brand of e-cigarettes to expand into the realm of reduced-risk products. Consolidation in the industry has made it easier for these two companies to crowd out smaller competitors in the space.

Image source: Getty Images.

Looking globally

British American and Philip Morris International are also among the biggest tobacco companies in the world, with others like Japan Tobacco and Imperial Brands also having key stakes in certain high-value markets. Philip Morris' empire spans across the globe, with operations in Latin America, Canada, the Asia-Pacific region, the European Union, and a broader area including Eastern Europe, the Middle East, and Africa. Its iQOS heated-tobacco system has gained prominence, especially in the Japanese market, where it has started to supplant traditional cigarettes.

British American now has global control over its brands thanks to its merger with Reynolds American. That includes unified marketing and distribution, but the company also stands to compete effectively in e-cigarettes and other parts of the market.

Other companies have smaller stakes but play key roles in certain areas. Japan Tobacco, for instance, has its fingers in the key Japanese market, and the success that Philip Morris has had on conventional tobacco sales there makes the island nation a battleground. Imperial Brands has served as an outside player to take on assets when major companies merge, such as receiving Lorillard's blu eCigs product line when the company merged with Reynolds American. These businesses are lucrative, but they don't have Philip Morris' and British American's scale.

Staying small

Finally, investors who prefer smaller stocks can find some good examples of companies with tobacco exposure but not the massive scale of their larger rivals. For instance, Vector Group has been a significant player in the U.S. tobacco market, but it now has a real estate business under its corporate umbrella that many believe has better prospects than its tobacco business. Vector has exposure to discount cigarette brands and hasn't made progress toward alternatives like e-cigarettes.

Universal goes even further down the supply chain, growing and distributing the leaf tobacco that manufacturers like Altria and British American need to make their cigarette products. Universal has also moved beyond cigarettes to provide testing for alternatives like e-cigarettes and vapor products. A good track record of dividend growth has many shareholders committed to the company.

Turning Point Brands is a pure play on alternatives to traditional cigarettes. The company provides rolling paper and cigar wraps for those who prefer to take loose tobacco and create their own smoking materials. It also produces chewing tobacco and vapor smoking products. The stock has gained attention as a provider of e-cigarette exposure.

Be smart about tobacco

In evaluating tobacco stocks, it's important to keep in mind that investors typically prefer to see high dividend yields from the companies that profit from cigarettes and similar products. Tobacco companies have been litigation targets for years, and shareholders have sometimes been reluctant to hold tobacco company shares during periods of maximum uncertainty.

Over the long run, even as the cigarette business has been in a long secular decline, major tobacco companies have found ways to remain profitable and identify new potential avenues for future growth. Tobacco stocks still have plenty of risk because of their exposure to what many consider a dangerous product. But given the huge rewards that they've given their long-term investors, tobacco stocks are still quite popular, and we can expect they'll continue to be for the foreseeable future -- especially as they start to make the transition toward the reduced-risk products that have so many people excited about their prospects for the long run.