Lorillard is probably the most attractively valued domestic tobacco company stock that investors could buy today. You’ve got a company that is buying back about 15 million shares of stock each year, raising the dividend by a rate around 10%, and the company is using its free cash flow to move into the e-cigarette market. Oh, and the Newport brand, which makes up 87% of the company’s sales, remains remarkably strong. The company trades at a little over 13x earnings, and gives investors a dividend yield over 5%. Any way I run the numbers, it seems that investors should experience total returns of at least 10% annually over the next 5-10 years, and considering that you have a growing 5% yield, it seems reasonable to think that at least half of your total returns will be in the form of cold, hard cash from the dividend.
Despite my calculations, I don’t own Lorillard. I’ll tell you why. I was reading the St. Louis Post-Dispatch this morning, and I got directed to a link on the University of Missouri homepage that mentioned that the campus will be going entirely smoke-free this July 1st. You can see a snapshot of what I am talking about here:
By itself, the fact that a flagship Midwestern university is going smokefree does not tell you a whole lot about Lorillard’s prospects, but it provides a microcosm of the kind of things you have to deal with when you are a tobacco shareholder. Usually, the conversation about tobacco investing focuses on the ethics and morality of owning tobacco companies, with one side of the debate not wanting to own a product that causes cancer and slowly kills people, while the other side recognizes individual autonomy and sees no harm in owning a tobacco company because the risks of usage should be clear to any adult that chooses to smoke.
That conversation is important to have, but I want to talk about the business side of owning a domestic tobacco company. For shareholders, all trends are negative. Sure, you might see Newport gain market share in a certain market, or e-cig sales might take off at a particular time, but for the most part, you are going to experience a non-stop onslaught of bad news if you own shares of a tobacco stock. You are always going to see reports of declining volumes. You are always going to be reading about a new place where smoking is banned. You are always going to be reading about a new restriction on the packaging. It does not stop. From a business perspective, you get hit with one bad piece of news after another.
Psychologically, do you want to deal with that? I’d rather take a 5% dividend from Royal Dutch Shell and call it a day. Charlie Munger said he likes companies that drown him in cash. It is so easy to find the oil, consumer staples, and healthcare companies that do that for shareholders. And, of course, tobacco companies have been drowning their shareholders in cash for the past century as well. It is just a question of whether you have the mentality to absorb the headline risk and want to own a company in an industry that is being undermined by the government at every turn—a new ban here, a higher tax there, etc.
Speaking from my own experience, I own two bad boy stocks. They are BP and Bank of America. With Bank of America in particular, I have spent more time monitoring that company than all my other holdings combined. It requires a time commitment on your part that is not necessary if, say, you buy shares in something like Coca-Cola or Johnson & Johnson. Before buying a tobacco company, it can be worth asking yourself: Are you prepared to deal with the headline risk? Are you prepared to spend the time necessary monitoring your stock? And even then, I’d ask myself: Aren’t there easier ways to make money?
Originally posted 2013-06-06 19:34:44.