Many first-time investors get attracted to the shiny, exciting-sounding stock stories. From 3D printing in 2013 to electric-vehicle (EV) stocks in 2021, the market never tires of selling exciting narratives to investors.
While investing in these themes may seem to work for a short while, these bubbles eventually burst. Anyone who bought shaky EV stocks at their top in 2021 knows this all too well.
But what if I told you some of the best investments weren't in the exciting stories but in the boring, consistent businesses that generate profits for shareholders year after year? Two unloved stocks that fit this definition are Altria Group (MO 0.45%) and British American Tobacco (BTI 0.19%).
These highly profitable tobacco giants have dividend yields close to 9%, well above the S&P 500 average. Put just $11,000 into these two stocks and they'll pay you $1,000 in annual dividend income -- dividends that have consistently grown over the years.
Here's why these two dividend payers belong in your portfolio today.
Tobacco stocks: Unloved but highly profitable
Since 2010, global cigarette volumes have declined. This occurred even earlier in the United States, which has seen cigarette usage decline for decades.
In 2010, close to 6 trillion cigarettes were sold around the world. In 2020, that number was just over 5 trillion, which has many investors worried about the future of tobacco stocks such as Altria and British American Tobacco. The companies own some of the leading brands such as Marlboro (Altria) and Lucky Strike, Camel, and Newport (British American Tobacco), and are clearly feeling the heat from this demand destruction.
And yet, since 2010, retail sales for tobacco companies have been higher, hitting $717 billion in 2020. This is also with major foreign-exchange headwinds, which makes it harder to grow in U.S. dollar terms.
How did the industry do this? Two words: Pricing power.
Tobacco brands have been able to outpace inflation by consistently raising the prices of their cigarettes, which counteracts volume declines. You could argue that these price increases can impact volume declines, which governments and society at large are likely happy with.
What's even better is that -- since these companies are selling fewer products and generating the same revenue -- profits are growing more quickly than revenue. For example, over the last 10 years, Altria's revenue is up just 16.8%, while operating income is up 44%.
Due to a large acquisition in 2017, British American Tobacco's growth is harder to fairly quantify, but over the last five years, its operating income is up 69%, while its revenue is only up 5%. Not bad results for what many perceive as a dying business.
MO Operating Income (TTM) data by YCharts.
Years of earnings growth ahead, investing in new products
With trillions of cigarettes still being smoked around the world every year, both Altria and British American Tobacco have many years of earnings growth ahead, even if volumes continue their steady decline. This should keep earnings growing for at least the rest of this decade. For reference, Altria believes it can grow its earnings per share (EPS) at a mid-single-digit rate through 2028.
But what about beyond this decade? Both companies are investing in reduced-risk nicotine products that are growing quickly and should start to help with consolidated earnings growth within the next few years. These include vapor, oral nicotine, and other products.
In 2022, British American Tobacco's "new categories" segment grew revenue 41% year over year to 2.89 billion British pounds. Altria's smoke-free business is much smaller today, but management believes the segment can hit $5 billion in sales by 2028 while growing volumes by 35% year over year. By 2030, the non-cigarette segments can be a much bigger part of the story and help both companies continue to grow EPS.
The dividend yields are high and will move higher
Today, Altria has a dividend yield of 9.3%. British American Tobacco's is 8.74%. Average the two numbers, and you have a blended dividend yield of 9.02%. That means if you put in just $11,000 equally into both these tobacco stocks, they'll pay you a handsome $1,000 in dividends each and every year, or $10,000 in cash within a decade.
But the real numbers should look even better than this, as both companies have a long history of growing dividends for shareholders. If the combined dividends per share grow at a 4% rate this decade, your initial $1,000 annual dividend payout will turn into $1,480 in 10 years. Twenty years from now, it will grow to $2,191. That's the beauty of compound interest and why it can pay big over the long term to buy stocks with long histories of growing their dividends.
If you're tired of losing money in narrative-based growth stocks, it may be time to start buying stocks with high dividend yields. Altria Group and British American Tobacco are two great places to start.
Brett Schafer has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco P.l.c. and recommends the following options: long January 2024 $40 calls on British American Tobacco P.l.c. and short January 2024 $40 puts on British American Tobacco P.l.c. The Motley Fool has a disclosure policy.
