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Why Philip Morris Could Be a Winning Stock

By Peter Stephens – Mar 20, 2014 at 10:00AM

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Philip Morris could be a strong performer in future. Here's why.

While shares in Philip Morris (PM -1.15%) have more than doubled since the bull market of the last five years began in March 2009, rising by 123%, they have lagged the S&P 500. Indeed, the wider index has easily outperformed Philip Morris, being up 172% over the same time period. Does this mean the stock is attractive at current price levels?

Strong growth
While the world economy is in far better shape than it was five years ago, it's easy to take growth for granted. Indeed, as all Fools know, booms and busts are just a part of our lives -- you can't have one without the other. That's why tobacco stocks, such as Philip Morris, can perform a useful role in a portfolio, since while demand for most goods and services is highly correlated with the level of economic activity and output, demand for tobacco products is, by nature, very steady and somewhat predictable.

For instance, since the start of the credit crunch, Philip Morris has increased diluted earnings per share in all but one year. While EPS was $3.31 in 2008, it had reached $5.26 in 2013, which is an increase of 59% in just five years and works out as an annualized growth rate of 9.7% -- not bad considering that period was one of the most challenging (economically) in not just American history, but also across large chunks of the world, too.

While the macroeconomic outlook continues to improve, with the Fed looking set to further taper its monthly asset purchase program, growth will not last in perpetuity. So, it's sensible to consider stocks such as Philip Morris, which not only has a business model that tends to perform just as well during downturns, but also has a track record of delivering on that potential, too.

Sector peers
Philip Morris isn't the only tobacco stock that has delivered strong growth in recent years. Two of the other major global tobacco companies, British American Tobacco (BTI -0.29%) and Imperial Tobacco (IMBB.Y -0.51%), have also experienced a relatively successful recent past. While Philip Morris has been able to grow EPS at an annualized rate of 9.7% over the last five years, British American Tobacco has been slightly ahead, at 10.9%, over the same period, while Imperial Tobacco is slightly behind its two peers, at 9% over the five-year period. All three figures are highly impressive and show that, even when the world economy was experiencing sluggish growth, tobacco stocks remained strong performers through the recession.

Impressive yields
There's little to choose from between the three companies in terms of their yield, either. While the S&P 500 currently yields just 1.9%, Philip Morris yields 4.7%. This is nearly 2.5 times as much as the wider index and highlights just how attractive Philip Morris could be as an income stock -- especially when savings rates are reminiscent of interest rates on checking accounts at present. Meanwhile, sector peers Imperial Tobacco and British American Tobacco are in the same ballpark as Philip Morris, also having impressive yields of 4.8% and 4.4%, respectively.

In addition, all three companies are mature players operating in a mature industry, so there could be scope to pay out a greater proportion of profits as dividends in future. For instance, the payout ratio of Philip Morris is currently 71% and, while this is fairly generous, it could be raised in future while still providing sufficient reinvestment of profits in the business for future growth. The same can be said to an even greater extent for British American Tobacco and Imperial Tobacco, which have payout ratios of 66% and 55% respectively.

As well as highlighting their income credentials, the yields of the tobacco stocks also highlight their attractive valuations. Indeed, value investors often use dividend yields to assess the relative attraction of stocks (provided payout ratios are not excessive, which they are not), so it could be argued that the relatively high yields of the three tobacco companies indicate this is an undervalued sector, with there being little to choose from between the yields on the three stocks.

Looking ahead
As well as offering relatively attractive levels of income and appearing to be undervalued, tobacco stocks such as Philip Morris also provide investors with stability. This is evidenced in the performance of the company over the last five years, when it was able to post near-double-digit EPS growth at a time when most companies were struggling to post any growth at all. Indeed, while we may be hopeful about the future performance of the economy, Philip Morris is unlikely to mind, and as such, it could prove to be a good place to be over the next five years.

Peter Stephens has no position in any stocks mentioned. The Motley Fool owns shares of Philip Morris International. 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.

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