Earnings Season Preview: These Tobacco Stocks Are Big on Dividends, but What About Earnings?

Here at the Fool we love our seasons: football season, flip-flop season, and our favorite, earnings season. It's that wonderful time of year when we get to celebrate those picks that outperformed, and be humbled by those that didn't.

Each quarter we get to arm ourselves with a new set of expectations and estimates to better judge the economic landscape. Taking the initiative to learn about the nuances for a given sector will place investors well ahead of many of their peers. Woody Allen put it best when he observed, "Eighty percent of success is showing up."

With that in mind, here is what you can expect to see out of some of the biggest tobacco companies this earnings season just by showing up and staying engaged.

Source: S&P Capital IQ.

Consumer goods companies tend to show remarkable resilience in tough times. During the depths of the financial crisis, the consumer goods sector hardly registered the news, falling only 16% from their 2008 high. Within this genre, there is a subsector that consistently rewards investors' portfolios with dividends and big gains: tobacco. Here is what to expect from everyone's love-to-hate industry this earnings season.

Source: S&P Capital IQ.

An equally weighted portfolio of the companies listed above from Jan. 1, 2008, would have had a straight return of 61.6% today, mocking the S&P's -11% return over the same period. Their average dividend yield is an index-rocking 5.1% -- that's more than twice the S&P's 2.4% yield.

With such steady performance, investors should just don their bathrobes and continue collecting fat payouts, right? Wrong. Tobacco is a well-established, but still dynamic industry. There are some macro and micro developments I'm keeping my eye on.

First, the macro developments: Tobacco companies in the U.S. face highly regulated advertising criteria. Soon enough, pictures of a black set of lungs or cancer-ridden mouths legally must comprise 50% of the front and back of cigarette packs. There are mixed reviews about these graphics' effectiveness, but the message is clear, the U.S. is not the most promising market for these manufacturers.

Therefore, I'm looking abroad where smoking is generally more accepted. Take Philip Morris as an example. PM was spun off from Altria in 2008 to protect it from U.S. litigation and allow it to more effectively pursue international opportunities. From 2005-2010, Philip Morris' Latin American and Canadian segment posted a 116% gain in revenue, their Asian segment posted a 77% increase in revenue, and there is still room to grow. A Gallup survey estimates that a third of Chinese citizens smoke. Consider that Philip Morris' 2010 revenue from all of Asia was just over half that of the European Union revenue, despite a far larger population.

Secondly, I'm watching some of the smaller players in this industry, Star Scientific (Nasdaq: CIGX) and Vector Group (NYSE: VGR). Star Scientific reported this little gem in its most recent financial statement:

ITEM 1A. 
RISK FACTORS
We have incurred losses for the past eight years and operating expenses are likely to continue to be greater than operating revenues in the foreseeable future.

Ouch. If management is correct and this trend continues, I'm bearish on these guys. Management is traditionally the rosiest predictors of future growth. If even they're bearish, what are we supposed to be?

Vector Group is showering shareholders with cash thanks to its 8.6% dividend. That's right, 8.6%. Alas, some things really are too good to be true. In Vector's case, its dividend payout ratio is 167%, meaning it's paying out more in dividends than its earnings can support. This is an unhealthy habit that it has maintained for a surprisingly long time, but like smoking, it's likely to catch up with it in a nasty way. I'm combing its financial statement to see clear language about how to improve this ratio, or maybe even reduce its dividend; otherwise I'm bearish on these guys, too.

How to play earnings?
There is no right or wrong way to play earnings this season. When it comes to tobacco, though, you can be sure that I'm keeping an eye on those companies with forward-looking international growth, particularly in China and Latin America, and these two smaller companies mentioned. I'm not the only one who finds tobacco stocks compelling. Our own Motley Fool analysts have compiled a special free report that contains an exclusive buy recommendation on one of the stocks listed above. You can access the report, "5 Stocks The Motley Fool Owns -- And You Should Too," by clicking here while it's still available. Happy earnings season.