Let's do a little back-of-napkin math to understand the value of a 9.5% dividend yield. Assuming all dividends received are reinvested at the same yield and no share price appreciation, a $10,000 position would soar to $20,669 in just eight years, more than doubling your money based on dividends alone. And in 20 years, your position would be worth a jaw-dropping $61,416. Unsurprisingly, such a generous payout strongly appeals to people saving for retirement and other long-term investors.
With that in mind, let's take a deep dive into Altria Group (MO -0.37%) stock to determine whether its 9.5% dividend is the opportunity of a lifetime or a yield trap that won't stand the test of time.
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What went wrong with Altria?
Extra-high dividend yields often go hand in hand with a declining stock since the yield is calculated as a percentage of the share price. And this seems to have partially been the case for Altria. Over the last five years, shares in the cigarette giant are down 15.6% to about $41 per share as of this writing. Over the same period, management increased the quarterly dividend 22.5% from $0.80 to $0.98 per share, further inflating the stock's yield.
Some of Altria's recent underperformance likely has to do with macroeconomic challenges like rising interest rates, which generally hurt fixed-income investments and dividend stocks. But Altria has company-specific challenges weighing on its results too.
For one, cigarettes are a slowly dying business, forcing tobacco companies to make up for declining sales volumes with higher prices. The industry also faces the ever-present threat of new regulation due to the negative health impacts of smoking.
Altria has tried to mitigate these challenges by branching into new markets. It invested billions in the once leading vape brand Juul Labs, but the company eventually gave up its stake at a huge loss after Juul become embroiled in a series of legal challenges. Altria continues to pursue diversification efforts, including its $2.75 billion acquisition of e-cigarette maker NJOY, which closed last summer. But this new venture will take time to scale up. As it stands, the company's business model mostly depends on traditional cigarettes, which aren't generating much organic growth.
Can Altria maintain its massive payout?
The good news is that Altria's limited growth potential won't necessarily hurt the dividend anytime soon. Tobacco use is falling, but it's doing so gradually. By consistently raising prices, Altria has increased its gross margin, making it easier to maintain profitability.
Data by YCharts.
Altria also repurchases shares frequently, which has the dual purpose of boosting earnings while reducing the cash it must pay out in dividends down the road.
Data by YCharts.
While Altria's third-quarter net revenue declined 4.1% year over year to $6.28 billion because of declining cigarette volumes, its operating income only fell 0.7% to $3.09 billion. And while the company's payout ratio of 77% may seem high, this is in line with the company's historical levels. For context, fellow Big Tobacco company Phillip Morris International has a payout ratio of 85%.
Is the stock a buy?
Altria has a 58-year track record of increasing its dividend payout annually, and the company doesn't appear at risk of breaking that streak in the near future. While the tobacco industry doesn't have much organic growth potential, a combination of cigarette price hikes, strong magins, and investments in new technologies should help the company keep its habit of generously returning capital to shareholders. The stock looks like a solid buy.
