Andrey Maximenko/iStock via Getty Images
Andrey Maximenko/iStock via Getty Images
Ben Graham, one of the greatest investors in history and Buffett's mentor, famously said
In the short-run, the market is a voting machine — reflecting a voter-registration test that requires only money, not intelligence or emotional stability — but in the long-run, the market is a weighing machine.”
25 million new investors since the pandemic might have been unaware of this timeless wisdom, as evidenced by the craziness of the last few years.
For example, at its peak, Zoom (ZM), one of the pandemic growth darlings, was trading at 125X sales. Not earnings, sales.
For context, during the tech bubble, Sun Microsystems CEO said that 10X sales were a crazy price to pay for even the best growth stocks.
Well, as you can see, speculators in Zoom who ignored valuations are learning a painful lesson in market reality.
Rule number one: most things will prove to be cyclical.
Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one.” - Howard Marks
And Zoom is hardly the only example of stock market madness we've seen in the last two years.
Some of the hottest pandemic names are down 70%, 80%, or even 97% from their February 2021 highs.
What's my point? That the stock market can be hilariously, and profitably wrong in the short-term.
Today, I wanted to highlight the four reasons why the market is dead wrong about Philip Morris (NYSE:PM ), one of the world's highest quality high-yield dividend kings.
PM is still up this year, easily outperforming the dividend aristocrats, S&P and Nasdaq. However, it recently fell 17% in a matter of days, including 6.6% on Monday, March 7th.
After a thorough and comprehensive examination of the best available facts we have today, I believe there is one simple conclusion we can draw.
Buy Philip Morris now, before everyone else does. In fact, I used PM's 7% crash to buy more for my retirement portfolio.
While I can't promise you this is the bottom, I can say with strong confidence that anyone buying PM today is likely to feel like a stock market genius in 5+ years, and here are four reasons why.
Why did PM, which was one of the hottest stocks of 2022, suddenly cliff dive 17%, including almost 7% in a single day?
It's likely due to concerns about Russia, which triggered a downgrade from JPMorgan.
JPMorgan dropped its rating on Philip Morris International to Neutral from Overweight due to near-term headwinds.
On the positive side, the firm noted that the tobacco giant is the global leader in both cigarettes and heated tobacco products, as well as being on track to cash in on nearly $10B of cumulative new generation products investments. On the negative side, JPMorgan analysts warned that the recent geopolitical can not be ignored.
"However, the recent tensions in Ukraine have clouded PMI’s ability to achieve its near and medium-term NGP targets, with Russia and Ukraine accounting for 23% of its HTU volume. Although the MT growth algorithm remains robust (FY21-24e organic sales/EBIT/EPS CAGR of +6%/+11%/+13%) driven by the highly attractive economics of HTP and an un-stretched balance sheet provides buyback support, external factors will prove too difficult to overcome." - Seeking Alpha
First of all, JPMorgan is not saying the long-term thesis is intact. In fact, they expect EPS growth of 13% through 2024.
JPMorgan is basically saying that they don't think that PM is likely to outperform in the SHORT-TERM due to the temporary headwinds of the Russian invasion.
Because no US company has more revenue from Russia and Ukraine than PM.
In fact, 23% of IQOS volumes are from these countries though overall sales are just 8% (6% Russia, 2% Ukraine).
PM temporarily suspended operations in Ukraine due to the war. Russian operations and sales continue though the collapse of the Ruble means a potential sharp decrease in sales in the coming months.
Are these serious challenges to PM? Absolutely.
Are they thesis-shattering events? Do they permanently reduce the company's free cash flow generating capacity by 7% to 17% as the recent price decline might have you believe?
Almost certainly not and here's the proof.
Pre-invasion, PM's median growth consensus from all 19 analysts that covered it was 10.7% CAGR.
What do analysts expect now that they've had time to digest this bad news?
10.3% long-term growth. I don't know about you but a very safe 5.4% yield and double-digit long-term growth potential sound like a mighty attractive investment proposition.
Now, let's consider the world's leading experts on fundamental risk, credit rating agencies, and the bond market.
S&P, Fitch, and Moody's all still rate PM A stable, indicating a 0.66% 30-year risk of default (bankruptcy).
The bond market, having had time to digest this news and JPMorgan's negative short-term assessment, has responded with a yawn.
Credit default swaps are insurance policies bond investors take out against default.
The price of CDS is a real-time fundamental risk assessment that is always changing as news breaks and the most conservative income investors on earth update their collective estimates of a company's bankruptcy risk.
Russia invaded on February 24th. JPMorgan downgraded PM on March 7th.
And a day later, the bond market's estimate of PM's fundamental risk is...
In the last six months, PM's CDS has been rock steady, during PM's wild price swings.
What does this tell us? That after digesting the new information, analysts, rating agencies, and the bond market all agree that PM's long-term thesis is intact.
So why did PM fall 17% in a matter of days? Was it in a bubble?
PM was trading at 18X earnings pre-Russian invasion. It historically trades at 16.5 to 17.5.
It was not significantly overvalued and that's why a 17% price crash in a few weeks, when the thesis is firmly intact, is such a potentially wonderful buying opportunity.
The Dividend King's overall quality scores are based on a 237 point model that includes:
credit default swap medium-term bankruptcy risk data
short and long-term bankruptcy risk
accounting and corporate fraud risk
historical cash flow growth rates
long-term risk management scores from MSCI, Morningstar, FactSet, S&P, Reuters/Refinitiv, and Just Capital
dividend-friendly corporate culture/income dependability
long-term total returns (a Ben Graham sign of quality)
analyst consensus long-term return potential
It actually includes over 1,000 metrics if you count everything factored in by 12 rating agencies we use to assess fundamental risk.
credit and risk management ratings make up 41% of the DK safety and quality model
dividend/balance sheet/risk ratings make up 82% of the DK safety and quality model
How do we know that our safety and quality model works well?
During the two worst recessions in 75 years, our safety model predicted 87% of blue-chip dividend cuts during the ultimate baptism by fire for any dividend safety model.
How does PM score on one of the world's most comprehensive safety models?
Approximate Dividend Cut Risk In Pandemic Level Recession
5% Margin of Safety For A Potentially Good Buy
PM: The 43rd Highest Quality Master List Company (Out of 509) = 92nd Percentile
The DK 500 Master List includes the world's highest quality companies including:
All global aristocrats (such as BTI, ENB, and NVS)
All 13/13 Ultra Swans (as close to perfect quality as exists on Wall Street)
PM's 90% quality score means it's similar in quality to such blue-chips as
Even among the most elite companies on earth, PM higher quality than 92% of them.
PM is the industry leader in the smoke-free future transition with almost 30% of sales now coming from reduced-risk products or RRPs.
PM has the 2nd most geographic diversification behind BTI, with 39% of sales from the EU, 15% from Japan, 14% from the rest of Asia, and 32% from the rest of the world.
Iluma is the new IQOS tech that gets around BTI's patents.
During the year, we laid the foundations for our long-term growth ambitions beyond nicotine in Wellness and Healthcare, including the milestone acquisitions of Fertin and Vectura, which provide essential capabilities for future product development." - CEO Q4 conference call
PM was able to close on its acquisitions of medical vaporizer companies, its first steps in an effort to diversify beyond nicotine.
2021's results were very strong.
Management may reduce guidance in the next earnings call, but one bad year doesn't mean a strong investment thesis break.
PM's 2022 guidance was so strong that 2022 is likely still to be a solid year of growth.
PM's IQOS volumes were up 25% in 2021 and 17% in Q4.
IQOS was 14% of volumes in Q4, driving 31% of sales.
IQOS is the world's 3rd most popular nicotine brand.
PM is on track to become a majority non-tobacco company by 2025.
In early IQOS markets, it has already reached and surpassed that goal.
In IQOS's top 10 markets, cigarette volume declines have been about 3X faster than globally.
72% of PM smokers who try IQOS stick with it and give up smoking for good.
IQOS is currently in 71 countries and PM has plans to expand that to 100 by 2025.
PM is on track to achieve its goal of $1+ billion in sales of medical products by 2025.
PM estimates it is now targeting an $89 billion annual wellness market (in 2025) that's growing at 11% annually.
Globally, nicotine is a $470 billion industry (up from $450 billion in 2020), growing at 4%.
PM is continuing to roll out new RRP products to keep its momentum and first-mover advantage.
Management remains confident it is on track to achieve 5+% sales growth and 9%+ earnings growth in the coming years.
And let's not forget about PM's industry-leading fortress balance sheet.
(Source: S&P, Fitch, Moody's)
PM has the strongest credit rating of big tobacco, with a 0.66% fundamental risk.
PM's leverage is very low and falling lower by the year.
PM's profitability is historically in the top 10% of peers.
Since the launch of IQOS, PM's profitability has been rising steadily, confirming a wide and stable moat.
PM's industry-leading profitability is expected to slowly but steadily improve over time.
Return on capital is expected to modestly rise over time.
According to one of the greatest investors in history, PM is about 16X higher quality than the average S&P 500 company.
PM's ROC has been trending higher for 17 years.
Rating agencies want to see 85% or less payout ratios.
PM's payout ratio is expected to keep falling steadily despite the fastest dividend growth in its industry.
$9.2 billion in post-dividend retained earnings is enough to pay off 28% of current debt or buy back about 6% of shares at current valuations.
Analysts expect PM to rapidly accelerate buybacks in the coming years, totaling $20 billion through 2025.
PM's future buybacks match its historical norm, which includes a long pause while it was investing $9 billion into IQOS. Since it started buying back shares in 2009, it has reduced its share count by almost 27%.
The bottom line is that PM is not a company at risk of being disrupted, it's the leading disruptor of its industry.
And the one with the best long-term growth outlook in the industry.
We've already seen how PM has turned a $9 billion investment in IQOS into the world's 3rd most popular nicotine brand.
What does that mean for PM's growth outlook? Well, in the long term, analysts expect 10.3% growth, in-line with management guidance.
Management says it can drive 5% top line growth and that's what analysts expect.
(Source: FAST Graphs, FactSet Research)
PM's dividend growth is expected to accelerate now that its payout ratio has fallen to management's target levels.
Long-Term Inflation And Risk-Adjusted Expected Returns
Analysts expect PM to potentially deliver almost 16% long-term returns, far more than the aristocrats, S&P, or Nasdaq.
In fact, it's more than just about any major investment strategy on Wall Street.
(Source: DK Research Terminal, FactSet)
While analysts expect the S&P to deliver 9X real return in the next 30 years, PM's superior growth and yield could potentially deliver 45X returns.
That's enough to turn a modest investment today into a small fortune in the coming decades.
(Source: DK Research Terminal, FactSet)
And that means potentially 5X better inflation-adjusted returns than the S&P 500 while you enjoy almost 4X better and safer yield.
PM started its current correction basically at fair value. And here's what a 17% overreaction by Mr. Market means for investors today.
Upside To Fair Value (NOT Including Dividends)
(Source: DK Research Terminal, FactSet)
PM is historically worth about 17X earnings and today trades at 14.5X forward earnings.
It's about 14% undervalued and if it returns to fair value and grows as expected in the next year, that's about a 21% total return.
Analyst Median 12-Month Price Target
Discount To Price Target (Not A Fair Value Estimate)
Upside To Price Target (Not Including Dividend)
Upside To Fair Value (Not Including Dividend)
12-Month Median Total Return Price (Including Dividend)
Discount To Total Price Target (Not A Fair Value Estimate)
Discount To Fair Value + 12-Month Dividend
Upside To Price Target ( Including Dividend)
Upside To Fair Value + Dividend
Morningstar's fair value estimates match mine exactly.
And analysts expect PM to deliver 28% total returns in the next 12 months, a forecast that's nearly all justified by its strong fundamentals.
Upside To Fair Value (Not Including Dividends)
For anyone comfortable with the risk profile, PM is a potentially good buy, bordering on a strong buy, and here's why.
For context, the S&P 500 is still overvalued, but a lot less than at the start of the year.
(Source: DK S&P 500 Valuation & Total Return Tool)
At the moment, the S&P 500 is a 9% further decline away from historical fair value, a forward PE of 16.8 (25-year average).
The S&P 500 is now at a valuation that offers basically flat total returns for the next two years.
Inflation And Risk-Adjusted Expected Returns
(Source: Dividend Kings S&P 500 Valuation And Total Return Potential Tool)
Over the next five years, analysts expect a respectable 7.5% annual return from the S&P, which is about 5.5% on a risk-adjusted basis.
However, the bond market expects 3.3% inflation to turn that into a far more modest 2.4% real return.
And here's what the power of high-yield Ultra SWAN value investing.
If PM grows as expected and returns to fair value, it could deliver 20% annual returns through 2023.
If PM grows as expected through 2027 and returns to fair value, that's 117% total returns, or 14% annually. That's about 3X more than the S&P 500 consensus.
DK DK Automated Investment Decision Tool
DK Automated Investment Decision Tool
For anyone comfortable with its risk profile, PM is one of the most reasonable and prudent high-yield blue chips you can buy today.
a yield that's almost 4X higher than the S&P 500 (and much safer) 2X the risk-adjusted expected returns 40% of your investment recouped in very safe and steadily growing dividends in the first five years
There are no risk-free companies and no company is right for everyone. You have to be comfortable with the fundamental risk profile.
How do we quantify, monitor, and track such a complex risk profile? By doing what big institutions do.
Here is a special report that outlines the most important aspects of understanding long-term ESG financial risks for your investments.
ESG is just normal risk by another name." Simon MacMahon, head of ESG and corporate governance research, Sustainalytics" - Morningstar
ESG factors are taken into consideration, alongside all other credit factors, when we consider they are relevant to and have or may have a material influence on creditworthiness." - S&P
ESG is a measure of risk, not of ethics, political correctness, or personal opinion.
S&P, Fitch, Moody's, DBRS (Canadian rating agency), AM Best (insurance rating agency), R&I Credit Rating (Japanese rating agency), and the Japan Credit Rating Agency have been using ESG models in their credit ratings for decades.
Dividend Aristocrats: 67th Industry Percentile On Risk Management (Above-Average, Medium Risk)
(Sources: MSCI, Morningstar, Reuters', S&P, FactSet Research)
PM's risk-management consensus is in the top 21% of the world's highest quality companies and similar to that of such other companies as
The bottom line is that all companies have risks, but PM is good at managing theirs.
When the facts change, I change my mind. What do you do sir?" - John Maynard Keynes
There are no sacred cows at iREIT or Dividend Kings. Wherever the fundamentals lead, we always follow. That's the essence of disciplined financial science, the math retiring rich and staying rich in retirement.
I know it can feel frustrating when a blue-chip's positive momentum is broken, especially for tobacco giants who have suffered through a multi-year bear market.
However, the reason that long-term value investing works at all is very simple. The market's definition of "long-term" is far longer than most people realize.
This is why wonderful companies with steadily growing sales, earnings, cash flows, and dividends can spend YEARS in bear markets that aren't justified by fundamentals.
And it's also why low-quality companies with questionable fundamentals can stay red hot for so long.
This is why it's important to remember that Ben Graham's weighing machine is always active and operating, even if it's behind the scenes during bear markets and bubbles.
Today, PM is once again suffering, at least in the short term. That's thanks to concerns about Russian and Ukrainian sales.
But when we analyze the company fully, meaning its balance sheet safety, growth runway, brands, management, dividend dependability, and long-term risk management prowess, one thing becomes clear.
PM is one of the highest safest, most dependable, and highest quality 5% yielding dividend aristocrats on Wall Street.
Today, it is 13% undervalued, and thanks to its generous 5.4% yield and industry-leading 10% growth prospects, represent one of the smartest choices for a diversified and prudently risk-managed portfolio.
That's why I just bought more PM and you might want to do the same.
Dividend Kings helps you determine the best safe dividend stocks to buy via our Automated Investment Decision Tool, Research Terminal, Phoenix Watchlist, Company Screener, and Daily Blue-Chip Deal Videos.
Click here for a two-week free trial so we can help you achieve better long-term total returns and your financial dreams.
This article was written by
Adam Galas is a co-founder of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 5,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.
The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha).
I'm a proud Army veteran and have seven years of experience as an analyst/investment writer for Dividend Kings, iREIT, The Intelligent Dividend Investor, The Motley Fool, Simply Safe Dividends, Seeking Alpha, and the Adam Mesh Trading Group. I'm proud to be one of the founders of The Dividend Kings, joining forces with Brad Thomas, Chuck Carnevale, and other leading income writers to offer the best premium service on Seeking Alpha's Market Place.
My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives.
With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and safe and dependable income streams in all economic and market conditions.
Disclosure: I/we have a beneficial long position in the shares of PM either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Dividend Kings owns PM in our portfolios.