Editors' Pick: Originally published Jan. 22.
Despite Thursday's bounce, U.S. stock indices continue to get close to bear market territory. The accepted definition of a bear market is a drop of 20% or more from stocks' previous peak. We're not quite there yet -- our markets are languishing in a "correction" phase -- but we are experiencing an extended period of falling stock prices that points to a potential bear market or even a recession in coming months.
Even with -- or perhaps because of -- the current wringing of hands and doom-and-gloom sentiments on Wall Street, there's a group of stocks that continues to perform. Far from being dangerous, these companies are actually safe bets in the current market climate.
"Vice stocks," which are shares of companies that cater to activities such as smoking, drinking and gambling, appear to be relatively impervious to market fluctuations. And tobacco companies are especially robust.
This Forbes article notes that last year Credit Suisse published a study that tracked the performance of Gerry Sullivan's $298 million Barrier Fund, a basket of vice stocks that includes five tobacco companies. The study compared that fund to a Vanguard fund that tracks a basket of socially responsible stocks. Since 2002, the Barrier Fund consistently outperformed the Vanguard one.
"Much of the evidence that we found suggests that 'sin' pays," the study was quoted saying by Forbes. "The rationale for 'vice' investing is that these companies have a steady demand for their goods and services regardless of economic conditions, they operate globally, they tend to be high-margin businesses, and they are in industries with high entry barriers."
Indeed, even though smoking is considered "risky behavior," tobacco companies themselves are far from dangerous and are in fact among the safest investment holdings in the world.
Like it or not, tobacco is here to stay. In fact, cigarette sales appear to be on the rise again in the U.S., according to this Bloomberg article. The article said that existing smokers are lighting up more often than before -- if they're not consuming tobacco or nicotine in other ways. The article also said analysts at Cowen & Co. had pointed to lower gasoline prices as a reason. The analysts said 60% of tobacco purchases occur at convenience stores and gas stations, and that Americans are using the money they save on fuel to purchase more tobacco.
Below we look at three "sinful" tobacco stocks that you should consider investing in now. And in each case, we'll highlight at one specific trend that bodes well for that stock.
1.Reynolds American (RAI)
Big Tobacco companies are breaking into the lucrative e-cigarette market. This up-and-coming niche is growing steadily, especially among teenagers. And a recent study discovered that e-cigarettes are far from damaging the traditional tobacco market: Dedicated smokers are likely to smoke both traditional cigarettes and e-cigarettes, rather than completely giving up the former.
Reynolds American is among the big companies that are targeting e-cigarettes. Its RJ Reynolds Vapor Company makes and sells VUSE e-cigarettes.
This focus on the developing e-cigarette market shows Reynolds American wants to profit from the latest trends. Yet its other businesses ensure that it will still benefit from demand for more established tobacco and nicotine products. Reynolds American owns the traditional Pall Mall, Newport and Camel cigarette brands; Natural American Spirt cigarettes, which appeal to consumers who like natural products; Grizzly and Kodiak snuffs; and Niconovum nicotine-replacement therapy products.
Reynolds American's strategy of having a diverse range of nicotine products is paying off for its shareholders. The stock is up 32% over the past year and has lost only about 1% year to date amid the dramatic broad market selloff. In comparison, the S&P 500 index has shed 8.5% so far in 2016.
Even after the stock's robust gains over the past year, it still appears slightly cheaper than its industry, according to data from Morningstar. On a trailing 12-month basis, Reynolds American has a price-to-earnings ratio of 17.2, vs. 20.1 for the industry. The median 12-month price target of analysts who cover the company is $51.50, suggesting that the stock could still gain about 12% from recent levels.
Smoking may not seem so popular in the U.S. anymore, and the actual percentage of the world's population that smokes is declining. But thanks to global population growth, the number of smokers around the world has continued to grow. And smoking remains popular in developing countries. Consider Indonesia, where there are more than 61 million smokers and smoking is on the rise among young people. That number is significantly greater than the 40 million adult smokers in the U.S. in 2014.
Philip Morris has strong footholds in markets such as Indonesia and is poised to profit from an increasing number of global smokers. The company sells cigarettes and other nicotine products outside the U.S. It owns brands across the price spectrum, from premium names such as Marlboro, Merit and Parliament, to midpriced brands such as L&M and Chesterfield, to local brands.
The stock has gained 1.3% over the past year and has lost only 1.8% so far in 2016, a fraction of the S&P 500's loss so far this year. Its trailing 12-month price-to-earnings ratio is 18.4, less than the industry average of 20.1, according to Morningstar data. The median price target of analysts covering the stock is $89.50, which suggests that shares can still rise 4%.
Tobacco companies tend to distribute generous dividends, a desirable feature for investors during bear markets. Altria, the former parent company of Philip Morris, sells cigarettes and other tobacco products in the U.S., as well as wine. Its stock has a sweet dividend yield of 3.9% right now. (Note that the other stock picks in this article have attractive dividends. Reynolds American yields 3.1%, while Philip Morris International yields 4.7%.)
Shares of Altria have risen 5.9% over the past 12 months and have lost only 0.6% since the start of the year. The stock doesn't appear as cheap as its peers, however. It's trailing 12-month price-to-earnings ratio is 21.6, which greater than the industry average of 20.1. That said, analysts still see plenty of upside. The median 12-month price target is $65, which suggests the stock could gain another 12%.
Regardless of public sentiment or antitobacco campaigns, the overall number of smokers around the world is on the rise. And staring down a bull market and even a potential recession, Big Tobacco stocks such as Reynolds American, Philip Morris International, and Altria are poised for steady global growth and could provide a safe haven for investors interested in solid returns in the current market climate.
As you can see, Big Tobacco looks like a great buy for investors right now. On the flip side, this group of 29 dangerous stocks is a terrible place for your money today. In fact, using a little-known financial "health test," the stocks on this list are a failure in every category! Click here now to make sure you don't make the mistake of owning one.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.