Dividends can be a ballast for your portfolio through the highs and lows of the market cycle. Buying quality stocks at a high dividend yield can provide your portfolio with a steady stream of income year after year, regardless of where the market is trading.
Traditionally, buying a broad market index fund was an easy way to build up your dividend income. But today, the S&P 500 index only pays a measly dividend yield of approximately 1.5%, as corporations shifted their capital returns strategy to share repurchases over the last few decades. That means investors looking for strong dividend income need to search for the few individual stocks still left with dividend yields well in excess of the broad market.
Lucky for investors today, one of these stocks has dipped this year and now trades at a whopping 8.8% yield with plans to grow its dividend per share each year. Enter: Altria Group (MO -0.37%). Should you buy shares of this high-yield tobacco stock? Let's take a closer look.
The leading U.S. tobacco brand, plus more
Altria is the parent company of multiple tobacco/nicotine brands. Most important is Marlboro, the leading premium cigarette in the United States with more than 50% market share in its category.
Even though cigarette volumes in the United States have declined at a steady 2.5% clip for decades, Altria has been able to keep its revenue climbing higher by steadily raising the price of a pack of Marlboros. Over the last 10 years, revenue is up a cumulative 17% even though cigarette use in the United States is down significantly. Due to rising margins, operating income has grown much quicker, up 44% in the last 10 years.
Outside of Marlboro, Altria owns leading cigar and oral tobacco brands such as Copenhagen, Skoal, and Black & Mild. Oral tobacco is much smaller than cigarettes (the segment did $443 million in earnings last quarter versus over $2.8 billion for the smokeable segment) but is still a great business with pricing power.
In the coming years, Altria will be looking to grow its sales not just through price increases, but in a transition to safer reduced-risk nicotine products it has acquired. These include the On nicotine pouches, which grew unit volumes by 48% year over year last quarter, as well as its recent acquisition Njoy, one of the leading e-vapor nicotine brands.
Investors should be watching the growth of these new brands closely as they will be important for Altria to keep growing sales in the years to come.
Two major risks for the business
Even though Altria has made progress with products such as On, it is still well behind its tobacco rival Phillip Morris International when it comes to reduced-risk brands. The international seller of Marlboro owns the leading nicotine pouch brand called Zyn -- which is taking a lot of market share from other oral tobacco products in the United States -- as well as the heat-not-burn tobacco brand Iqos.
Falling behind in these new age segments presents a major risk for Altria as the company could see accelerated market share losses for Marlboro if more young people switch to tobacco-free nicotine solutions.
Another major risk is, well, Altria's own management team. The company has a recent history of bad capital allocation, most famously spending $12.8 billion to get a minority stake in Juul Labs. With the company facing a potentially huge legal burden and declining market share, Altria was forced to write down its stake in Juul and cut ties with the start-up, burning more than $10 billion in shareholder value in just a few years' time.
Funneling dollars into bad investments means fewer dollars for Altria to pay out as a dividend. If management makes a few more of these blunders, it could really hurt its ability to grow the dividend.
Speaking of which...
Can the dividend grow?
At the company's recent investment day, Altria outlined guidance to grow its dividend at a mid-single-digit percentage each year (likely meaning between 4% and 6% growth). As long as management doesn't shoot itself in the foot, the math should work to reach this target.
Over the last 10 years, Altria's free cash flow per share has grown by more than 100% cumulatively through share repurchases, margin expansion, and steady revenue growth.
MO Free Cash Flow Per Share data by YCharts
Even if free cash flow per share only grows by 50% over the next 10 years (less than half the rate of the previous 10), that will give Altria the cash flow capacity to grow its dividend per share by 4% each year. Outside of a few brief periods, Altria's free cash flow per share has been higher than its dividend per share for the last 10 years, which shows that its dividend payout is sustainable as long as the business remains durable.
There are some long-term risks to watch with the growth of reduced-risk products, but at these prices, Altria shares are a bargain. You can buy the stock at an 8.8% dividend yield -- more than 4 times the S&P 500 average -- with a path to growing the dividend by 4%+ each year for the foreseeable future. That sounds like a perfect income stock to me.
