Retirees need to be especially mindful of where they invest their money as they have less time to recover any losses that might occur and because these funds tend to also be their main source of income. That means avoiding high-risk investments and focusing more on stocks and other investment vehicles that generate passive income. Tobacco giant Philip Morris International (PM 0.31%) can be a good fit for such an investor.
In a market where many dividend stocks and bonds offer minuscule dividends and payouts, Philip Morris International (PMI) is a dividend stock that many investors have come to depend on for a healthy payout. Let's look at three reasons why this stock is a favorite suggestion for retirees looking at investment options.
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1. PMI has a generous dividend it can afford to raise
Passive income is usually high on the list of retiree must-haves, and dividend stocks offer many a great way to get paid. Tobacco stocks have a historical reputation as good dividend payers; it's their incentive to attract investors because they haven't been high-growth companies for a few decades now. There are various reasons investors avoid this category of stocks commonly referred to as sin stocks.
PMI certainly falls into this category; its dividend yield is 4.9%, more than double what 10-year U.S. Treasury bonds currently yield and way more than the savings account at your bank. It also helps that the company grows the payout each year, effectively giving shareholders a regular raise. PMI has increased its dividend for 13 consecutive years, each year since it went public in a spin-off from sister company Altria Group.
PM Cash Dividend Payout Ratio data by YCharts
You can see in the above chart that PMI spends just over 71% of its free cash flow on its dividend (the dividend payout ratio). For many companies, when the ratio starts getting about 65% to 70% it's considered a potential red flag by investors because it could signal that the company cannot afford to keep raising the dividend without going into debt or affecting operations. But tobacco is a very profitable product with a relatively low overhead and solid and consistent operating margins. PMI converts roughly $0.32 of every revenue dollar into free cash flow, so the business can afford to pay out a lot of cash to investors.
2. PMI generates enough growth to get the job done
Even as a retiree, you want your investments to continue growing over the years. A stock might pay a good dividend, but a falling share price can still point to a business in decline, which isn't good.
PMI bases all of its financials in U.S. dollars but generates revenue in international markets. This foreign currency revenue must be converted to U.S. dollars, meaning that financials will fluctuate depending on how strong the dollar is trading against these foreign currencies. You can see below how an increase in the trade-weighted U.S. Dollar Index (which tracks the dollar against the country's trading partners) has an inverse relationship with PMI's revenue. When the dollar gets stronger, PMI's revenue falls because it's getting less favorable exchanges when it converts those foreign sales to dollars.
PM Revenue (Annual) data by YCharts
A sharp increase in the dollar in 2015 hurt PMI's revenue, but its organic growth is steadily overcoming the stronger dollar. If the dollar were to weaken, it would have the opposite impact, turbo-charging revenue. PMI and other tobacco stocks have benefited (some say wrongly) from the addictive qualities of nicotine and it allows them to get away with consistently raising product prices knowing their customers have a hard time quitting. These consistent price increases help push revenue and margins higher over time.
PMI is also taking a long-term approach to its core business; its IQOS system is a heated tobacco product that is actively trying to convert cigarette smokers. It heats the tobacco instead of burning it, which it claims is far less harmful to the user's health. IQOS revenue now makes up almost 30% of the company's total, and management projects it could be more than 50% by 2025. Analysts estimate earnings-per-share growth at nearly 8% per year for the next three to five years.
3. Financial stability has helped keep the stock safe
If PMI experienced unexpected challenges, it might have to lean on its balance sheet to keep running smoothly. Excellent financials can be a safety net for investors, and a company's balance sheet can be crucial for a retiree.
PMI currently has $4.5 billion in cash on hand, enough to fund the company's dividend for more than two quarters if the business completely shut down and revenue went to zero overnight. PMI does have about $25.7 billion in long-term debt, but the credit rating agency S&P Global gives Philip Morris an "A" rating, meaning that its balance sheet is "investment-grade," with a strong capacity to meet its financial obligations. In other words, the company is financially healthy.
Checking all the boxes
Ultimately, you need to identify stocks for your portfolio that fit your individual goals, time horizons, and risk tolerance. Philip Morris International is a value stock that checks many of the main boxes that many retirees and more conservative investors look for.
If the company can continue growing its bottom line at 8% per year (as analysts think it can), the combination of growth and a nearly 5% dividend should give investors a solid shot at double-digit percentage total returns and a nice stream of passive income to boot. Its well-rounded appeal and strong fundamentals make Philip Morris International possibly my favorite stock for retirees this year.
