Does Investing In Big Tobacco Make Sense?

http://investmentunderground.com/6062/featured/does-investing-in-big-tobacco-make-sense

by Jan Michael Acebo

Governments around the world are ramping up regulations on tobacco products. In light of this, are tobacco companies the best stocks for investors today? Do they compensate investors for the industry-specific risk that they face?

Unfortunately, the answer is no. Cigarette companies are getting dividend investors hooked on unsustainably high yields. The headwinds for these stocks and their unstable dividend policies are bad omens. Alternative high dividend-paying stocks are suggested to help income investors kick the cigarette stock habit.

This negative perspective is agnostic to the reservations of socially responsible investors, who have (slightly) more incentive to stay away. However, boycotting these shares does not represent substantial activism.

Australian Tobacco Regulations

In Australia, tobacco companies are now required to place images of cancer victims and gangrenous limbs on cigarette packs. To comply with new government standards, there must be images and health warnings covering seventy five percent of the front of cigarette packs. New packages will display disgusting images including tongue cancer, a skeletal man dying of lung cancer, or an infected foot. Additional warnings have to cover the sides of the packages and ninety percent of the back.

Health officials are hopeful that new cigarette packaging will dissuade more consumers from smoking. After most of the packaging is not covered in cautionary warnings, the remainder is required to be drab. According to the state law, the background of the packaging must be a specific greenish-brown color and any trademarks or product names have to be in Lucida Sans font. State officials will look closely for deviation from these regulations.

Government officials hope that the new packaging will curtail the recruitment of young people as smokers. Australia’s health minister Tanya Plibersek said, “Young people are the ones most affected by the packaging and by the advertising, and no parent wants their kid to start smoking.”

Australia is just the beginning. Margaret Chan, the World Health director-general said, “With so many countries lined up to ride on Australia’s coattails, what we hope to see is a domino effect for the good of public health.” Countries including the United Kingdom, Turkey, New Zealand, India, and Russia expressed interest in more severe plain packaging rules.

Tobacco Warning

Stifling Australian tobacco regulations are likely a preview of the future in other countries. There is no way to predict the future, but that the possibility of such hard impositions on packaging and advertising could manifest in any country. Since this risk could become reality, tobacco stocks should be much, much cheaper than other stocks.

Consider the following cigarette and non-cigarette companies:

It appears that cigarette companies are using by unsustainably high dividend payout rates to keep investors hooked. These dividends will not last forever since payout ratios above 60% don’t leave enough margin for error if earnings decline or if governments initiate new restrictions on your products.

Fortunately there are alternative stocks which offer superior valuation metrics. Each of the alternative stocks on this list, CA Technologies, Gannett, GameStop, and Intel are trading at lower valuations than the listed cigarette companies. They also offer high dividend yields above 4% with sustainable payout ratios. Think of them as the dividend equivalent of nicotine patches to help you quit the tobacco habit.

Underweighting Tobacco: Not Socially Responsible Enough

Investors who abstain from cigarette stocks for moral reasons are making the right choice for their portfolios, albeit for dubious reasons. These socially responsible investors do not want to benefit from an industry that destroys health, reduces life-expectancy, and hooks customers through addiction.

Moral and ethical stances are great, but would a boycott of tobacco stocks on the secondary market really make a difference? The toxins in tobacco leaves and smokers don’t know that you own shares.Whether or not you buy these shares doesn’t dramatically impact new tobacco ventures. Buying shares through the stock market pays someone who bought the stock from someone else, who in turn bought the stock from someone else, who in turn bought the stock from someone else…who in turn bought the stock from someone else, who helped launch the company.

If you actually care about reducing or preventing tobacco-related deaths and health problems, here are three potentially effective ways to make a difference:

1) Boycott tobacco companies. The best way to not smoke is to not smoke. Show friends and family how tobacco will ruin their lives using real data and tell them what they will miss out on (family events, the next iPhone, whatever) if they die early.

2) Political action. Write your congressman or join an activist group.

3) Don’t invest in new tobacco ventures or grow tobacco yourself.

This brief discussion is not meant to shake your moral compass. In fact, it is meant to highlight which routes travel furthest in the direction to which it points.

Boycotting these shares is smart for your stock portfolio but makes a poor excuse for activism. You should avoid them for financial reasons, but don’t kid yourself: you are not saving lives by underweighting big tobacco.