Which Tobacco Stock Is a Buy Today?

Welcome to "Stock Smackdown," where two of your favorite stocks go head to head in a battle for superiority. They'll each be judged on a series of objective merits, including valuation, earnings quality, and dividend quality. We'll also take a look ahead at some more subjective measures -- Wall Street's analysts will get their say, but so will The Motley Fool's top market minds.

The winner will be the stock that racks up the most points at the end of their competition. Let's go to ringside and meet our two combatants, Altria (NYSE: MO) and Lorillard (NYSE: LO).

In this corner…
The American tobacco industry isn't exactly in growth mode right now, but it's fought back against mediocre sales to maintain a long-term position as a high-yielding safe haven. Altria and Lorillard both continue to reach new yearly highs. Both secured spots on Fool analyst Dan Dzombak's Value Investor 500, with Altria placing 160th and Lorillard coming in at 499.

Altria and Reynolds American (NYSE: RAI) have responded to demands for profitability with workforce reductions. Lorillard's resisted that trend thanks to growing shipments of both its premium and discount brands. Discount-brand cigarettes have been nipping at Altria's heels -- Vector Group's (NYSE: VGR) Liggett and Reynolds' Pall Mall have also seen greater popularity during America's growing cost-consciousness.

Altria's a much weaker company than it once was since divesting its foreign operations as Philip Morris International (NYSE: PM). Philip Morris is one of the few bright spots in the publicly traded global tobacco industry, and its post-split gains have been almost entirely due to growing earnings. However, even international tobacco is starting to face the same public-health headwinds that Altria's dealt with for years. An international Altria wouldn't be much competition for Lorillard, so let's stick to the States.

Valuation battle
We use many different numbers and ratios when talking about the value of a stock. The price-to-earnings ratio is the standard, so we'll check each company's current P/E and five-year historical average P/E. We'll also use price to free cash flow today. Earnings can be gamed with a number of different accounting tricks, but free cash flow is harder to manipulate, making it a favored metric for many here at the Fool.

In each case, the difference between a stock's current ratio and its five-year average ratio will be more important than the numbers themselves. Stocks trading significantly lower than their average ratios may have more room to return to that middle ground.

For the tiebreaker, we'll check one less-used financial metric: the debt-to-equity ratio. A company with little or no debt is usually in better shape than one leveraged to its eyeballs.

Source: Wolfram Alpha and YCharts. Winners in bold.
* Lorillard debt to equity not available due to negative equity.

Despite negative present equity, Lorillard takes this round with lower key ratios and a shorter distance between its current results and its averages. Let's see if Lorillard can stay in the lead after earnings quality's tallied up.

Earnings quality battle
A company can be cheaply valued without being a good value. To balance out our valuation fight, let's look at a few key earnings statistics for each company. We'll look at operating and net margins, a five-year annualized rate of earnings growth, and consecutive years of both positive earnings and earnings growth since 1992, two decades ago. A company with no momentum today is less likely to become a superstar later -- it has happened before, but not often.

Sources: Yahoo! Finance and Wolfram Alpha. Winners in bold.

This is getting lopsided. Lorillard thrashes Altria all up and down the board, losing in the years-of-profit category only because it only became an independently traded public company a few years ago. Will it hold the line on the dividend battleground?

Dividend battle
A growing company is great, but one that pays you back is even better. Let's see how strong and stable each company's dividends really are. We'll examine yield and two payout ratios, both the standard net income-based ratio and the free cash flow payout ratios. We'll also examine each company's five-year annualized dividend growth rate, and each company's current streak of uninterrupted payments.

Those payout ratios are important, particularly the free cash flow payout ratio. Companies that pay out more than they take in can rarely sustain such practices for long.

Sources: Yahoo! Finance, Morningstar, and Dividata. Winners in bold.
* Annualized over four years, from 2008/2009 to 2011/2012.

The hits play on for Lorillard, as it misses out on a clean sweep due to another age-related technicality. Will it pick up the final victory and become the undisputed champion of the American tobacco stocks?

Battle for the future
Looking at the past is well and good, but let's go further. How do the world's most engaged market participants view these companies? Let's see what Wall Street's analysts expect from these companies, and what our Motley Fool CAPS community thinks.

Sources: Yahoo! Finance, Motley Fool CAPS.

That's got to sting a bit for Lorillard. Despite winning all three of the statistical fights, it can't win the market's hearts like Altria. Still, the numbers are on Lorillard's side, including the most important one from our analysts -- the forward growth estimate. I'll add my vote to Lorillard's CAPS chorus with an outperform CAPScall today thanks to its victory here, but I'll also keep my outperform call from last year active on Altria. Just because it's lost this battle doesn't mean it'll lose the investing war.

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