{"id":36045,"date":"2013-02-08T11:24:45","date_gmt":"2013-02-08T16:24:45","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=36045"},"modified":"2013-02-08T11:24:46","modified_gmt":"2013-02-08T16:24:46","slug":"at-current-prices-tobacco-is-no-go","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/02\/08\/at-current-prices-tobacco-is-no-go\/","title":{"rendered":"At Current Prices, Tobacco is No-Go"},"content":{"rendered":"

By The Sizemore Letter<\/u><\/a> <\/p>\n

Back in December, I recommended that readers \u201cwatch their ash<\/a>\u201d<\/strong> when investing in tobacco stocks.\u00a0 In their hunt for yield in a seemingly yield-less world, investors had bid the price of most tobacco stocks to levels that no longer made sense.<\/p>\n

Tobacco is a no-growth business and an industry in terminal decline.\u00a0 As a case in point, American teenagers are more likely to use illegal drugs that to light up a cigarette<\/a>.<\/p>\n

In the circular logic of the stock market, the lack of growth is part of what has made tobacco stocks such fantastic investments in recent years.\u00a0 Management doesn\u2019t have to reinvest in the business or to fund an expensive marketing budget.\u00a0 And there are no white elephant projects or unrealistic management spin.\u00a0 They understand the economics of their business, and they do the only things that make sense: they pay out gargantuan dividends and aggressively buy back their shares.<\/p>\n

But the key here is investor expectations.\u00a0 Investors had low expectations for the sector and were unwilling to pay up for earnings. Ultimately, the success of any investment depends on the price you pay, and tobacco investors were able to enjoy monster returns precisely because the stocks were cheap.<\/p>\n

Well, they\u2019re not anymore.\u00a0 Not by a long shot.\u00a0 By Wall Street Journal estimates<\/a>, the forward P\/E on the S&P 500 is 13.5.\u00a0 Philip Morris International (NYSE:$<\/span>PM<\/a>)<\/b> is significantly more expensive than that, and Altria (NYSE:$<\/span>MO<\/a>)<\/b> and Lorillard (NYSE:$<\/span>LO<\/a>)<\/b> are essentially at the same valuation.<\/p>\n\n\n\n\n\n\n\n\n\n
Company<\/td>\n\n

Ticker<\/p>\n<\/td>\n

\n

Forward P\/E<\/p>\n<\/td>\n

\n

Dividend Yield<\/p>\n<\/td>\n

\n

Payout Ratio<\/p>\n<\/td>\n

\n

1-Yr Div. Gr. Rate<\/p>\n<\/td>\n<\/tr>\n

Philip Morris International<\/td>\n\n

PM<\/p>\n<\/td>\n

\n

15.5<\/p>\n<\/td>\n

\n

3.90%<\/p>\n<\/td>\n

\n

63%<\/p>\n<\/td>\n

\n

10%<\/p>\n<\/td>\n<\/tr>\n

Altria<\/td>\n\n

MO<\/p>\n<\/td>\n

\n

13.5<\/p>\n<\/td>\n

\n

5.10%<\/p>\n<\/td>\n

\n

83%<\/p>\n<\/td>\n

\n

7%<\/p>\n<\/td>\n<\/tr>\n

Lorillard<\/td>\n\n

LO<\/p>\n<\/td>\n

\n

13.4<\/p>\n<\/td>\n

\n

5.20%<\/p>\n<\/td>\n

\n

71%<\/p>\n<\/td>\n

\n

19%<\/p>\n<\/td>\n<\/tr>\n

Intel<\/td>\n\n

INTC<\/p>\n<\/td>\n

\n

9.9<\/p>\n<\/td>\n

\n

4.20%<\/p>\n<\/td>\n

\n

41%<\/p>\n<\/td>\n

\n

7%<\/p>\n<\/td>\n<\/tr>\n

Microsoft<\/td>\n\n

MSFT<\/p>\n<\/td>\n

\n

8.6<\/p>\n<\/td>\n

\n

3.30%<\/p>\n<\/td>\n

\n

45%<\/p>\n<\/td>\n

\n

15%<\/p>\n<\/td>\n<\/tr>\n

Cisco Systems<\/td>\n\n

CSCO<\/p>\n<\/td>\n

\n

10<\/p>\n<\/td>\n

\n

2.70%<\/p>\n<\/td>\n

\n

23%<\/p>\n<\/td>\n

\n

75%<\/p>\n<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

 <\/p>\n

This should not be.\u00a0 Tobacco stocks should not be more expensive than the rest of the market.<\/i><\/b><\/p>\n

Yes, all pay significantly more in dividends than the S&P 500, which pays a pitiful 2.0%.\u00a0 But look at the payout ratios.\u00a0 All pay out the majority of their earnings as dividends, whereas the payout ratio of the S&P 500 is less than 30%.<\/p>\n

Meanwhile, take a look at the technology stocks at the bottom of the chart.\u00a0 Intel (Nasdaq:$<\/span>INTC<\/a>), Microsoft (Nasdaq:$<\/span>MSFT<\/a>)<\/b> and Cisco Systems (Nasdaq:$<\/span>CSCO<\/a>)<\/b> all trade for 10 times or less expected earnings, and all have modest dividend payouts with plenty of room for growth.\u00a0 They pay a little less in dividends than tobacco stocks\u2026but not that much less.\u00a0 And their dividend growth rates are comparable (with the exception of Cisco, whose growth rate is off the charts).<\/p>\n

Last month I joked that chipmaker Intel was my favorite \u201ctobacco stock,\u201d<\/a> <\/strong>arguing that Intel had quite a bit in common with the likes of an Altria and its peers:<\/p>\n

As the Big Tobacco has proven for decades, companies in declining industries can make excellent investments under the right conditions.\u00a0 If you have a dominant market position (think back to Warren Buffett\u2019s \u201cmoats\u201d), a conservative balance sheet, and have ample cash flow for share repurchases and dividends, you can do quite well by your investors even in a shrinking market. It\u2019s worked for Big Tobacco investors, and it will work for Intel investors as well.<\/i><\/p>\n

The same could be said for Microsoft and Cisco.\u00a0 Tech is the new tobacco.<\/strong><\/p>\n

To be fair, tobacco companies have certain advantages that \u201ctobacco companies\u201d like Intel lack.\u00a0 A chemically-addicted clientele, for starters, as well as an unrivaled ability to raise prices virtually at will.\u00a0 Whenever a progressive-minded (or cash-strapped) city decides to hike the taxes on cigarettes, the taxes flow right through to the customer.\u00a0 Not too many companies have that ability.<\/p>\n

But that said, I\u2019m betting that Big Tech is a better investment than Big Tobacco.\u00a0 Investors are expecting no growth from Big Tech.\u00a0 So, if actual results prove to be even marginally better than disastrous, investors should enjoy a decade or more of solid gains.<\/p>\n

Microsoft and Intel in particular may or may not ever figure out the mobile market.\u00a0 But that\u2019s ok.\u00a0 Given that a zero percent probability is currently priced into shares, mobile success can be thought of as an embedded call option that could end up paying off in a big way.\u00a0 And if that option is never exercised, you\u2019re still getting the existing businesses at \u201ctobacco\u201d prices.<\/p>\n

SUBSCRIBE <\/a><\/strong>to Sizemore Insights<\/em>\u00a0via e-mail today.<\/p>\n

The post At Current Prices, Tobacco is No-Go<\/a> appeared first on Sizemore Insights<\/a>.<\/p>\n

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