Tobacco giant Philip Morris (NYSE:PM) is a time-tested favorite for income investors. The company offers a generous dividend yield, supported by strong cash flow and increased like clockwork, year by year.
But our panel of Motley Fool contributors found several things not to like about Philip Morris and its seemingly bulletproof dividend. There's more to income investing than simply sending out large quarterly checks, and Philip Morris isn't always the best choice.
Anders Bylund (American Tower): There's nothing terribly wrong with buying Philip Morris for its dividend. The generous 4.9% yield is paired with decent long-term stock returns, and investors in the tobacco giant have beaten the market overall over the last decade.
But then again, Philip Morris isn't a stock that would let me sleep easy at night. From that perspective, I would much rather own wireless infrastructure titan American Tower.
One of these companies builds and operates cell towers that form the backbone of several other industries, fuels economic growth, and connects people across the globe. The other one cheerfully promotes a addiction-forming product that keeps hospital beds smartly occupied, and its side effects kill two-thirds of all users. Call me a bleeding heart, but I know which business model I'd rather support and profit from.
You might scoff at American Tower's paltry 1.1% dividend yield today, but it won't stay that low forever. The company is growing its payouts much faster than Philip Morris does -- and it absolutely must continue doing this to keep its tax-efficient status as a real estate investment trust.
If these trends continue, and all else being equal, the effective yield on the American Tower shares you buy today would catch up to the yields on a batch of 2015 Philip Morris shares within seven years. But all else is not equal, as Philip Morris is fighting a losing battle against anti-smoking public opinion while American Tower is growing by leaps, bounds, and timely asset acquisitions.
Come back in five or 10 years, and I bet a pretty penny (in real-world stock holdings) that American Tower shareholders will have left Philip Morris investors fuming with jealousy at the tower operator's superior returns.
American Tower's surging dividend payouts will only add salt and lemon juice to those wounds.
Andrés Cardenal (PepsiCo): When investing in dividend stocks, investors need to look beyond the yield, as dividend growth can be an even more important factor. PepsiCo's dividend yield of 2.6% does not look exciting in comparison to Philip Morris' smoking-hot 4.9%. However, PepsiCo's potential for rising dividends means the drinks and snacks giant in future years could easily outperform the tobacco leader on a total return basis.
In February, PepsiCo announced its 43rd consecutive annual dividend increase, which shows the company is one of the most reliable and dependable dividend growth stocks in the market. In addition, PepsiCo has an active share buyback program, so investors are being rewarded via both growing payouts and a shrinking share count. By the end of 2015, PepsiCo will have distributed nearly $65 billion to shareholders via dividends and stock repurchases over a decade.
Competitive strengths are the primary driver of PepsiCo's growing cash flow over the long term. The company has an extraordinary portfolio of 22 brands that each generate over $1 billion in annual revenue. Besides, PepsiCo's gargantuan distribution network keeps competitors at bay, allowing the company to sustain pricing power and profitability.
The industry is changing. As consumers pay more attention to calories and the overall health impact of the food and drinks they consume, PepsiCo will need to adapt to changing demand. Fortunately for investors, brands such as Gatorade, Tropicana, and Quaker Oats show management is making smart moves in that direction.
Joe Tenebruso (Verizon Communications): In Tier 1, the real-money portfolio I manage for The Fool, I seek out the businesses best positioned to profit from major global trends. I believe, though, the trend is moving against Philip Morris. Although the anti-smoking movement might not be as intense in international markets (where Philip Morris conducts its business) as it is here in the U.S., I believe it's only a matter of time before the devastating effects of smoking provoke consumer backlash worldwide. That's not the type of situation where I want to invest my money.
So where would I invest?
One trend I find compelling is the surge in mobile data usage. According to StatCounter Global Stats, mobile traffic was 25% of total Internet traffic as of last May -- up from only 0.9% in May 2009. I believe Verizon Communications is the business best positioned to profit from this trend.
Verizon has the best network and largest customer base among U.S. wireless service providers. That scale is a powerful competitive advantage, because building out a network is incredibly expensive, making it difficult for new entrants to displace a titan like Verizon.
These competitive dynamics were on display in Verizon's fourth-quarter and full-year results. The wireless business added 2 million net subscribers during the quarter, despite heavy promotional activity by its competitors. And Verizon's growing customer base is paying more for its services, with average revenue per account rising by 3.9% for the year.
Looking ahead, expect Verizon to continue to shift its operations away from its wireline business and toward its more profitable wireless business. Recently the company sold off noncore assets in order to fund new spectrum purchases. These moves should better position Verizon to profit from the trend toward wireless communications and corresponding surge in mobile data usage. That, in turn, should keep a rising stream of dividend income flowing to its shareholders.