In a speech to the Financial Planning Association, legendary Vanguard Founder and former CEO John Bogle made an observation that's absolutely critical to understanding where the best stock returns come from -- and how to find the next great stock to buy.

He told the assembled guests that only three things drive investor returns:

  • Dividends
  • Earnings growth
  • Changes in valuation

That's all it comes down to. Historically, stocks have returned 9.6% per year on average -- 5%, 4.5%, and 0.1% from dividends, earnings growth, and valuation changes, respectively. Naturally, the best stocks to buy are the ones that will produce the highest combined return.

So which alcohol and tobacco stocks will earn investors the best returns today? Obviously, no one can say with total certainty. You should always take future estimates with a grain of salt, particularly when analyst forecasts are involved. In fact, studies show that analysts' long-term earnings per share estimates tend to be off by as much as 40%, so I've reduced their estimates accordingly.

But investing is all about making predictions based on imperfect knowledge of the future. As long as we're aware of the need to think critically about a company's prospects and to build a margin of safety into our stock purchases, analyst estimates can be a helpful tool for generating ideas. In this series, I run the numbers to round up the stocks that represent their implied best buys today. Here are our assumptions:


Dividend Yield (Current)

5-Year Growth Rate (Reduced by 40%)

Assumed Price-to-Earnings Ratio (in 2016)

Constellation Brands (NYSE: STZ) 0% 8% 16
Philip Morris International (NYSE: PM) 4.6% 7% 15
Compania Cervecerias Unidas 3.3% 6% 15
British American Tobacco (NYSE: BTI) 4.1% 7% 15
Anheuser-Busch InBev (NYSE: BUD) 2% 8% 17
Lorillard 4.4% 6% 14
Diageo (NYSE: DEO) 3.1% 6% 15
Altria (NYSE: MO) 5.9% 5% 13
Molson Coors Brewing 3.1% 3% 11
Reynolds American (NYSE: RAI) 5.4% 5% 13

Source: S&P Capital IQ. Includes stocks on major U.S. exchanges capitalized over $200 million, with positive earnings and at least one analyst issuing long-term earnings estimates. 2016 price-to-earnings multiple estimated at 8.5 + growth rate.

And here are their implied five-year annualized returns for shareholders. I've ordered the three return components by their reliability -- first dividends, then earnings growth, then valuation.


Dividend Return*

Earnings Growth Return

Valuation Return

Implied Cumulative Annual Return

Constellation Brands 0% 8% 20% 28%
Philip Morris International 5% 7% 0% 12%
Compania Cervecerias Unidas 3% 6% 0% 10%
British American Tobacco 4% 7% (3%) 8%
Anheuser-Busch InBev 2% 8% (3%) 8%
Lorillard 5% 6% (2%) 8%
Diageo 3% 6% (3%) 7%
Altria 6% 5% (5%) 6%
Molson Coors Brewing 3% 3% 0% 6%
Reynolds American 5% 5% (5%) 5%

Source: Author's calculations. *Assumes dividend growth at rate of earnings growth.

The raw numbers tell us that these are the 10 most promising names in alcohol and tobacco stocks. Of course, analysts' growth assumptions for any individual company could prove overly optimistic or pessimistic, as could their future valuations, so the implied cumulative returns are hypothetical. That said, this list helps you focus on this sector's highest potential returners -- and provides an excellent starting point of names for further research.

So don't stop here. If any of these stocks interest you, add them to your personalized stock Watchlist to find out more about them. If you haven't started one yet, click here to begin.

Fool contributor Ilan Moscovitz does not own shares in any companies mentioned here. You can follow him on Twitter @TMFDada. The Motley Fool owns shares of Diageo, Altria Group, Molson Coors Brewing, and Philip Morris International. Motley Fool newsletter services have recommended buying shares of Philip Morris International, Molson Coors Brewing, Diageo, and Compania Cervecerias Unidas. Motley Fool newsletter services have recommended creating a bear put ladder position in Lorillard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.