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Tobacco Dividends Plentiful and Reliable

By Michael Hooper - Oct 23, 2013 at 6:00PM

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Tobacco stocks have a history of providing steady dividends. Here are four tobacco companies with yields ranging from 4.6% to 9.3%.

Investors looking for yields may want to consider owning tobacco stocks. Dividend yields for tobacco stocks are more than double the yield of the S&P 500 index. Tobacco companies have been some of the most reliable dividend payers in American corporate history, despite health care initiatives against tobacco. I believe adults have the right to smoke tobacco as long as they know the health risks. Tobacco stocks with dividend payout ratios below 100% of their earnings can be lucrative additions to a dividend portfolio.

If you are going to own tobacco, you might as well own successful companies that have survived and thrived despite government oversight, high taxes and public health care initiatives to stop smoking.

Dividend yields for Altria Group ( MO 1.16% )Lorillard Tobacco Group ( LO.DL )Reynolds American ( RAI ) and Vector Group ( VGR 0.06% ) range from from 4.58% to 9.30% -- substantially more than the S&P 500's yield of 2%.

Tobacco companies have been resilient in looking for opportunities to create new markets in cigars, leafy tobacco and electronic cigarettes to offset declines in total cigarette consumption, according to the Centers for Disease Control and Prevention.

Below is a chart showing key metrics for these dividend-paying stocks.

Name Yield Payout Ratio Net Margin Sales Growth Dividend Growth Since 2009
Altria Group 5.27% 80.56% 18.15% 3.44% 36.36%
Reynolds American 4.96% 86.01% 18.91% -0.50% 43.52%
Lorillard 4.58% 65.66% 18.26% 5.90% 66.71%
Vector Group 9.30% 311.36% 4.45% -4.31% 14.36%

Source: Charles Schwab Research and tobacco company web sites

Vector Group pays a phenomenal yield of 9.30%. This yield may not be sustainable if the company continues paying out more than it earns annually. The payout ratio for Vector Group over the past 12 months has been 311.36% of earnings or literally three times net income. Vector Group also compares poorly with a net margin of only 4.45% compared to over 18% for the other three tobacco companies. Vector Group sells a lot of discounted cigarettes which reduce its margin but still bring in revenue.

Investors want to own stocks with rising dividends. Lorillard has raised its dividend 66.71% since 2009, Reynolds' dividend is up 43.52%, and Altria's is up 36.36%. Vector Group comes in last here with a paltry 14.36% increase since 2009.

In addition to a cash dividend, Vector Group has paid a 5% annual stock dividend every year since 1999.

These are mature companies without much sales growth. Yet, stock performance for the sector is pretty good. Reynolds stock is up 20.76% year-to-date through Oct. 23. Lorillard is up 25.25%, Vector is up 17.07%, and Altria is up 15.36%.

Adapting to change
Like any business, tobacco companies have had to adapt to changing markets and legal conditions. Some consumers said they wanted natural tobacco without any additives. Tobacco companies responded by selling bags of plain tobacco. As taxes went up, tobacco companies found creative ways to reach lower-price point customers. A package of five flavored cigars sells for around $3.00. In July, Reynolds introduced its digital vapor cigarette called Vuse in Colorado. Reynolds is already seeing high levels of repeat customers buying Vuse replacement cartridges.

Smokers spend fortunes on tobacco. At $5.00 per day, a pack-a-day smoker spends $1,825 annually. But the real cost is human life. Cigarette smoking is the single leading cause of preventable disease and death, leading to more than 400,000 deaths annually in the United States.

Tobacco has been smoked by human beings for thousands of years. It will continue to be enjoyed, although the freedom to smoke in public is nearly gone in the United States. No doubt there will continue to be health care initiatives against tobacco. Tobacco's heyday in America has long been over, but it still is a great place to find good dividend paying stocks. Tobacco companies can and do raise prices to maintain their profit margins and pass on regulatory expenses to consumers.

Conclusion
Tobacco stocks offer higher-than-average dividend yields. These dividends are sustainable if the company's payout ratio is less than 100%. Altria, Reynolds American and Lorillard all pay out less than their earnings. They have strong profit margins -- which enable them to weather future health care initiatives and continue paying dividends.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Altria Group, Inc. Stock Quote
Altria Group, Inc.
MO
$44.43 (1.16%) $0.51
Vector Group Ltd. Stock Quote
Vector Group Ltd.
VGR
$15.71 (0.06%) $0.01
Reynolds American Inc. Stock Quote
Reynolds American Inc.
RAI
Lorillard, LLC Stock Quote
Lorillard, LLC
LO.DL

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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