Happy Belated Small Business Owner’s Day! Speaking of which, did any of you see that American Express commercial showing support for American small businesses by playing the Simon & Garfunkel “America” while showing the families of those operating mom-and-pop stores? If you are familiar with Simon & Garfunkel’s work, you might have noticed a little tweak in the lyrics. The commercial played: “Let us be lovers / We’ll marry our fortunes together. / I’ve got some real estate / Here in my bag. It took me four days to hitch-hike from Saginaw. / I’ve come to look for America.”
For those of you that have been fans of Simon & Garfunkel’s music, you probably noticed the fusion of the first verse with the third verse. If American Express had chosen to play the commercial with the original sequence and flow of the song, the commercial would have gone as follows: “Let us be lovers / We’ll marry our fortunes together. / I’ve got some real estate / Here in my bag. / So we bought a pack of cigarettes and Mrs. Wagner pies / And walked off to look for America.”
Isn’t that interesting—companies like PepsiCo do not hesitate to hire rappers like Lil’ Wayne to advertise their products (though they ultimately ended the relationship after Lil Wayne rapped about the slain African-American teenager Emmitt Till)—but American Express finds it necessary to censor out the mentioning of a cigarette purchase from an iconic American soft rock song.
Me, being me, started thinking about the cues moments like these provide for further reflection on tobacco investing. I remember Charlie Munger once saying something to the effect of, “The numbers are the easy part. Anyone can see that. It’s getting the story right that requires much more insight and confidence.” When I look back at pictures of the original Busch Stadium where the St. Louis Cardinals played baseball, there was a giant eagle hawking (ha ha ha) Anheuser Busch’s signature brand Budweiser and the giant Marlboro Man in the outfield. That was it—those were the big baseball sponsors. Now, you have the ad agency that works for American Express distorting the lyrical flow to engineer a commercially acceptable version that scrubs Simon & Garfunkel’s originality to tug at the heartstrings of the American people in an unblemished way.
Trying to figure out the future for tobacco investments is tricky because success in spite of long-term doom and gloom (for investors) have proven to be a critical part of the investor’s returns. People expect the worst, and profits grow a bit more than expected, and then you have this situation where Altria has compounded at a rate of 19.33% over the past twenty years when you include the Philip Morris International, Kraft, and Mondelez spinoffs. Because the company buys back stock, and raises the prices of its tobacco products at a rate greater than the 3.5% annual volume loss, owners continue to make money. Usually, the dividend is also in the 5% or 6% range, and that amplifies returns for those that reinvest. When volume losses accelerate, and/or price increases of tobacco plus buybacks cannot offset these volume losses, you will encounter severe problems with any tobacco stock you own.
My solution to this dilemma? Buy a large block of Philip Morris International and take the dividends and reinvest them elsewhere each year. This would be especially wise right now, as Philip Morris International trades at 17x earnings while Altria trades at 22-23x earnings. Heck, Philip Morris International offers a 4.6% starting dividend yield while Altria offers a 4.1% dividend yield. This is one of those situations that should never happen—Philip Morris International is still growing its volumes in some countries internationally, and should have a higher earnings per share and dividend per share growth rate as the scope of the international tobacco business is much more vast and favorable than the climate that exists for Altria in the United States.
There is a significant downside that comes with what I recommend—taking Philip Morris International dividends and reinvesting them elsewhere will likely lower your compounding rate unless you take the dividends and do something like buy Visa, Ross Stores, Disney, Becton Dickinson, Nike, or Franklin Resources at fair value.
I read anecdotal accounts of investors reinvesting into more and more shares of Altria, quarter after quarter, reaching a point where 30-50% of their portfolio is in the tobacco giant. I would not be comfortable at all with that kind of reliance. When I wrote recently about how concentrated bets are often part of an investor’s story on the part to mega-wealth, there is no doubt that Altria, Reynolds American, and Philip Morris International have been companies appropriate for that task. The problem is that they come with a long-term wipeout risk—it might be only 5% or 15% depending on how you calculate it—but it’s always there, ready to emerge from the background. Someone who had 30-50% of their wealth in something like Exxon, Nestle, Coca-Cola, or Johnson & Johnson is in a much better situation because the downside risk is more favorable—at worst, you could face a prolonged period of weak growth with those companies.
Anyway, it’s funny where an American Express ad featuring Simon & Garfunkel lyrics can send my mind. The relationship between the enormous cash flows inherent to the tobacco business, and the offsetting political risk of higher taxes and limiting regulations, continues to fascinate me. I think the job of an intelligent portfolio manager is to make sure the price isn’t too steep if he gets the outcome wrong.