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Most investors who buy Altria Group (NYSE:MO) shares don’t do it in the hope of explosive price gains. The stock performed worse than the S&P500 for years. But the dividend? That’s another story. Altria is a world-class dividend stock with a huge yield and a track record of payout increases spanning more than five decades.
The Dividend King has shown some life this year. This month, the stock climbed above $56 to its highest price since early 2022 before retreating to around $50.
This pullback could make this a perfect buying opportunity for dividend-hungry investors looking for double-digit annual investment returns.
Slowly. Stable. Trustworthy.
Many investors consider tobacco companies to be the old guard of the stock market. The number of smokers in the US has been declining for decades, and it is well known how terrible tobacco use of any kind is for your health. Altria, which sells cigarettes, chewing tobacco and smokeless nicotine products in the United States, still derives the vast majority of its revenue and revenue from cigarette sales. Marlboro is Altria’s flagship brand.
But even today, people seemingly underestimate how resilient the tobacco industry is. The addictive nature of nicotine and high regulatory barriers for newcomers to the industry have allowed Altria to steadily increase its per-pack prices, more than offsetting the fact that Altria is selling fewer cigarettes each year.
The combination of these price increases and the company’s share buybacks was enough to increase Altria’s free cash flow per share overall.
No one will confuse Altria with a fast-growing company. Profits are growing at low single-digit rates. The bottom line is that the country continues to achieve slow and steady growth. Will it stay that way forever? No one can know for sure. However, there are no signs of this stopping anytime soon. Analysts estimate that Altria will grow earnings just over 3% annually over the next three to five years.
This is not a yield trap
A company’s management team may be able to choose how much dividend to pay, but they don’t have full control over the dividend yield, as that also depends on the share price. Sometimes high returns can entice investors; they can seem like easy money. However, a stock’s dividend yield may be high because the market believes the company cannot afford to maintain its payout at previous levels, or because other warning signs are driving the stock price lower.
In that context, high-yield stocks could prove to be bad investments, especially if the company cuts its dividend. Such low-quality stocks with high yields that are on the path to lowering payouts are sometimes called yield traps.
Altria’s dividend yield is high because earnings are growing slowly. The market knows that most of the return on the stock will come from dividends, and the share price reflects that. Yet Altria is not a yield trap because its payout is safe. The company routinely spends about 80% of its profits on dividends.
That’s a higher dividend payout ratio than most companies, but Altria’s operations require little investment. It’s not even allowed to advertise because of tobacco laws. That unique business model allows Altria to comfortably pay out more of its profits as dividends than most companies.
Market-based investment returns are possible
Altria has been around for generations and is one of the best performing stocks ever. However, it has underperformed S&P500 for years. Yet it could become a market-beating stock again.
Thanks in large part to the artificial intelligence trend, the S&P 500 has had a tremendous 31% rally over the past year and is trading at a price-to-earnings (P/E) ratio of 24, well above the historical average. While attempting to time the market is usually a losing strategy, there may be more volatility in the future, and if a recession occurs in the US, it could trigger a market decline.
Meanwhile, Altria has a fairly simple path to double-digit annualized investment returns. Based on its current dividend yield of 8.1% and expectations of 3% to 4% annualized earnings growth, it could generate an annual return of between 11% and 12%. With a price-to-earnings ratio of less than 9, Altria’s valuation is reasonable enough that investors are less likely to see a further dramatic decline in the stock’s valuation. Now that the The Federal Reserve has started cutting interest ratesthe market could even support higher valuations for high-yield stocks like Altria.
Altria shares can provide reliable dividends and even surprise investors with their overall return potential. The slow growth means investors shouldn’t overpay for the stock, so the recent dip provides a perfect opportunity to add shares while the share price still makes sense.
Should You Invest $1,000 in Altria Group Now?
Consider the following before purchasing shares in Altria Group:
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Justin Pope has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has one disclosure policy.
Time to buy the dip on this 8.1% hyper-yield dividend king? was originally published by The Motley Fool