Historically, cigarette companies have been some of the best stocks to hold over the long run. Though many may have moral reasons for opposing such a path to riches, the combination of an addictive product and low input costs combine to form a powerful force for dividend investors.
I recently pointed out that folks should be careful when it comes to investing in shares of Vector Group (VGR 1.56%) and its dividend. I want to expand on that today, by pointing out two more things that today's investors need to be well aware of before buying shares.
Vector offers a stock dividend, as well as a cash dividend
One of the things dividend investors know all too well is quarterly cash deposits from stocks can be taxed by the IRS. But Vector utilizes a technique that technically shouldn't create any value in theory, but in practice it actually does: a yearly stock dividend.
The difference between a cash dividend and a stock dividend is that in the former, cash is paid to shareholders, and in the latter, shareholders receive extra shares. The key here -- from a tax standpoint -- is that cash dividends are taxable, while stock dividends aren't.
The way that it works is rather simple. Ever since September 1999, for every 20 shares of Vector Group that an investor held, they would receive an extra share. This year, the shareholder who went to bed on Sept. 10 with 1,000 shares of Vector, woke up the next morning with 1,050 shares.
In theory, the stock should go down 5% whenever this happens -- and indeed, that is what's happened. Over the past five years, Vector's stock has gone down by an average of 7% on the day of the stock dividend, while the S&P 500 has been flat on those days.
But if we back up and look at the stock's performance during the month of September in general -- and compare it to the S&P 500 -- we find something different.
As you can see, though Vector's stock price underperformed the market, after taking the stock dividend into account, it has handily beaten the market. One of the reasons for the difference between movement on the day of the stock dividend, and during the month of September, is that investors start bidding up shares in early September to take advantage of the dividend, only to sell their shares as soon as they get them.
In the end, however, it seems to all come out in the wash. This means that the company's whopping 7.2% dividend yield could actually be bumped up to 12.2% if you include the stock dividend.
But don't get too excited
Before running out and buying shares, however, there's one glaring problem with such a high payout: It is unsustainable. While Vector could keep issuing its stock dividend endlessly into the future (it doesn't cost the company anything), it needs money to pay the cash dividend.
And when it comes to free cash flow -- which is what any company uses to pay its dividend -- there has been a significant shortfall in recent years.
As I detailed in my previous article, the reasons for this shortfall are plentiful. The most salient is that company has been losing market share in the ultra-discount cigarette industry. The volume of shipments has, unsurprisingly, been falling as well.
To remedy the situation, management decided to expand into -- of all things -- the real-estate market. Over the past few years, Vector has established a 70% stake in Douglas Elliman, one of the top real estate agencies in the New York City area. So far, it has turned out to be a good move, but it remains to be seen if that division of Vector can quickly close the gap to help fund the company's dividend.
In the end, I think there are better bets for your money.
