5 Reasons You Can Still Count on These Dividend Champions

Tobacco companies have long been the haven of dedicated dividend investors. Altria Group (MO 1.91%) and Philip Morris International (PM 2.82%) are particular favorites of the dividend crowd. Reynolds American (RAI) and Lorillard (LO.DL) are also well liked because of their high dividend yields. However, as the tobacco industry comes under regulatory fire, some investors are starting to worry that their investments in these blue chips are at risk. Fortunately, there are five big reasons that investors can still count on these dividend champions.

Reason No. 1: High yields
It is hard to earn a decent income from dividend investing if you only buy low-yielding stocks. The key is to buy stocks that have higher yields relative to other companies of similar riskiness. The largest tobacco companies have wide moats and stable cash flows. This stability makes their dividends as safe -- or even safer than -- blue chips like Deere & Co and 3M.

Despite the safety and stability of their dividends, the big tobacco companies trade at higher yields than companies with similar or greater risk profiles in other industries.

Source: Morningstar

Dividend investors can earn a higher yield by investing in tobacco stocks and take on the same risk as they would if they invested in Deere or 3M. That sounds like a good deal to me.

Reason No. 2: Growing dividends
Aside from yield, dividend growth is perhaps the most sought-after trait among dividend investors. Reynolds American increased its dividends in all but one year since 1999; its dividend remained at $0.95 per share in 2004, the same as in 2003. In all the other years, dividend investors were richly rewarded with large dividend hikes. Since 2000, Reynolds' dividend has grown at 9.35% per year -- a wonderful outcome for investors who got in at a good yield.

Lorillard is also a perennial dividend increaser. Since becoming an independently traded public company, Lorillard has grown its dividend at a 14.5% compound annual growth rate. As long as the menthol category remains strong, Lorillard's dividend increases can continue to grow at a double-digit rate for years.

Once hailed as the ultimate dividend stock, Altria is still a reliable dividend increaser even after the various spinoffs that occurred in 2007. Both Altria and its international sister company, Philip Morris, have continued to increase their dividends each year. Since 2009, Altria has grown its dividend at an 8.7% annual rate, while Philip Morris has grown its dividend at a 12.43% annual rate. Count on these stable dividend payers to keep growing their dividends for years to come.

Reason No. 3: Smarter capital allocation
Back in the 1980s and early 1990s, tobacco companies were doing everything they could to run away from the industry. The company now known as Altria bought General Foods and Kraft Food (NASDAQ: KRFT) in an attempt to diversify its operations. Reynolds bought Nabisco in order to accomplish the same thing. The result was that the tobacco companies ended up holding a bunch of expensive -- and sometimes struggling -- food companies.

Since then, tobacco companies have wised up and are focused on managing the decline of the industry and returning capital to shareholders. The lack of reinvestment required -- cigarettes, after all, have Warren Buffett-approved economics -- enables tobacco companies to pay out a high percentage of earnings as dividends. Altria, for instance, has a startling 81% payout ratio. Given its stable cash flows, this payout level is safe for Altria.

Source: Morningstar.

Reason No. 4: Consolidation could hit the industry
Some analysts have speculated that a new wave of consolidation will sweep the tobacco industry now that the risk of litigation has taken a backseat to the risk of regulation. Earlier this month, it was reported that Reynolds was in talks to acquire Lorillard. It has also been suggested that British American Tobacco could make a bid for Reynolds.

Although dividend investors seek dividends above all else, the potential for large capital gains as a result of consolidation makes tobacco companies even more attractive.

Reason No. 5: Stable industry
The first four reasons would fall flat if not for the fifth reason that tobacco companies are great dividend investments: cash flow stability. Companies pay dividends with cash. Therefore, stable cash flows are crucial to maintaining a reliable dividend. Despite all of the negative sentiment and a declining core product, tobacco companies reliably increase free cash flow in most years -- making them supremely attractive to dividend investors.

Foolish takeaway
Altria, Philip Morris, Reynolds, and Lorillard are boring stocks with limited growth prospects. However, they are good ol' dividend stocks that offer stable and increasing returns over time -- and offer significant upside if consolidation reemerges. These are the perfect stocks for dividend investors to buy and hold.