Value stocks are shares in companies that trade at low multiples relative to their earnings and growth potential. They are an excellent way for investors to minimize the risks associated with growth stocks that have high expectations built into their valuations. Let's dig a little deeper to find out why tobacco giant Philip Morris International ( PM 1.75% ) is one of the best value stocks to buy right now.
Pivoting to reduced-risk products
U.S. smoking rates peaked in the 1960s before declining sharply as more information about the negative health implications became available. (Smoking rates are still growing in some international markets, though.) Philip Morris has turned this secular challenge into an opportunity by pivoting to "reduced-risk" products like IQOS, a system that heats tobacco without burning it. This reduces the release of harmful chemicals relative to cigarettes, according to company research.
There is still debate about the safety of heated tobacco systems compared to their combustible counterparts. But the U.S. Food and Drug Administration (FDA) has authorized Philip Morris to market IQOS as a modified risk tobacco product. Regulators elsewhere in the world have also approved IQOS, helping to boost sales of the product.
Philip Morris sold almost 19 billion heated tobacco units (HTUs), including IQOS, in the third quarter: 18.7% more than in the prior-year period. Sales of the new products helped offset declines in traditional cigarette volume, which fell 9.8% to roughly 165 billion units. Cigarettes still make up the majority of Philip Morris' product mix, but HTUs now comprise over 10% of total volume, up from less than 1% in 2016. Reduced-risk products in general (including vaporizers) represent 23% of revenue.
A dirt cheap valuation
Philip Morris' net revenue fell by 2.6% to $7.4 billion in the third-quarter, but management expects net revenue and adjusted diluted earnings per share to expand at compound annual growth rates (CAGRs) of at least 5% and 8%, respectively, once COVID-19-related economic headwinds abate.
The company is guiding for full-year diluted EPS of $5.03 to $5.08 for 2020. This would give the stock a price-to-earnings (P/E) multiple of roughly 16 at the time of writing. That P/E multiple is dramatically lower than the S&P 500 average of 37. And Philip Morris looks attractively valued considering the company's potential for price hikes and long-term organic growth through reduced-risk products.
Why this matters for investors
Philip Morris' dirt cheap valuation and potential for future earnings growth allow the company to pay a large dividend. Investors receive an annualized $4.80 per share, which is a yield of 5.94%. That's not too shabby, considering the S&P 500's average dividend yield is just 1.59%.
Philip Morris' payout ratio of roughly 95% of EPS shows that management is committed to returning practically all of the company's profits to shareholders.