Tuesday, September 22, 2020

What if Altria went to zero?

A few months ago I read an article where someone expressed their hope that tobacco giant Altria (MO) goes to zero. I did not link to this controversial opinion, in order to discourage that.

Altria Group, Inc. (MO) manufactures and sells cigarettes, smokeless products, and wine in the United States.

The company last raised its quarterly dividend by 2.40% to 86 cents/share in July 2020. This marked the 51st consecutive year of annual dividend increases for this dividend king. During the past decade, this dividend king has managed to grow distributions at an annualized rate of 9.70%.

Altria earned $1.87/share in 2010 and is expected to earn $4.31/share in 2020.

The stock is cheap at 9 times forward earnings. The stock yields 8.60%. Check my last review of Altria from the time it joined the dividend kings list in 2019.

It was a welcome way to look at some key principles of dividend investing, notably the fact that dividends represent a return of investment and a return on investment. It is also a good refresher on my risk management guidelines.

For example, if you bought a share of Altria today for $40/share, you can expect to earn an annual dividend of $3.44/share. This means that as long as the dividend stays constant, the investor receives 8.60% of their original investment back each year. At this rate, the stock will pay for itself with dividends alone within eleven or twelve years. Assuming that the business is still intact, and generating profits, you would have an ownership stake worth something as well. If history is any guide, Altria will likely continue to grow dividends for the foreseeable future, which could translate into high valuations over time. This will all be driven by slow but steady growth in earnings per share. All this growth would result in an even faster dividend payback.

In other words, dividends represent a return of investment and a return on investment in the case of Altria, because just by dividends alone an investor today would recover their purchase price within 11 - 12 years, if not quicker.

However, assuming the company’s business model continues going on uninterrupted, it is likely that the investor would have received dividends and have something of value as well. Assuming that the share price stays at $40 until September 2021, an investor today would generate a close to 8.60% return merely by collecting their distributions. 

If Altria keeps growing, and earnings per share and dividends double within a decade, I could reasonably expect that the share price would double. Therefore, the total return would be very good for the patient investor who held through thick or thin. Those growing dividend payments would represent a growing portion of their returns over time. If market participants are less gloomy on Altria in a decade, and P/E expands from less than 10 today to 15 in 2030, that would be an added tailwind behind future stock appreciation.

However, if Altria continues stumbling on, it may do the unthinkable and cut dividends. While I believe that most of Altria's issues are self-inflicted wounds ( as discussed here), it is possible that I am not being objective. Sometimes, early success may make us blind to changes. This is why I always plan to sell after a dividend cut, and then reevaluate with a clear head. 

The other notable fact is that dividend investing is almost free, because we do not employ expensive fund managers that charge a percentage of fees under management. We also do not pay money for commissions either. Most dividend investors are the worst clients for brokers, because they buy and hold, and seldom trade actively. 

Imagine that you held Altria in a diversified portfolio of 100 individual companies, and the portfolio is equally weighted and worth $100,000 at its inception. 

If you paid a fund manager a 1% annual fee to manage that portfolio, you are essentially losing one Altria per year in management fees alone. 

But, if you paid someone to buy stocks for you 1%/year, they would earn that 40 cents on a $40 stock each year that you work with them. If the stock stays at $40/year, and you keep holding for 20 years, you would have paid them close to $8/share. 

If that position went to zero, not all is lost in a taxable account. The share that cost $40 can be sold at zero, resulting in a $40 capital loss that can be offset against other gains or against income on the first $3,000 of losses. If you are in the 24% tax bracket, you will save $9.60 in taxes. This means that your loss is never 100%, which is a small consolation. If you managed to collect dividends net of taxes for a sufficient period of time to cover your cost, and sold for a $40 loss, the tax savings alone could have been the determining factor between a gain and a loss.

This is where you need to determine your risk management method. Some investors end up reinvesting dividends back into the same company, which works wonderfully if that company ends up delivering outstanding returns. It doesn't work as well if the company ends up failing.

Other investors take the dividends in cash, and re-deploy them elsewhere. This method works best if the investor deploys the cash into other companies, and the original dividend payer stumbles onto hard times. Redeploying dividends elsewhere doesn't work as well when the original dividend payer is a dividend dynamo, which Altria was between 1926 and 2015.

That being said I am not suggesting that Altria is going to zero anytime soon. However, I view the high dividend yield as a warning sign today. While I like Altria, I would be selling the minute it declares a dividend cut. While I reinvest some of the dividends back in one of my portfolios, I generally get most of my Altria dividends in cash to redeploy elsewhere or to spend.

Relevant Articles:

Analysis of Altria's Recent Deal Activity

Dividend Payback from six quality dividend stocks

Dividends Offer an Instant Rebate on Your Purchase Price

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