Investing in Tobacco Stocks

The tobacco industry may be reviled by some, but it has been a big winner for investors for much of its history. Throughout the 20th century, tobacco stocks were among the best performers, benefiting from an addictive, highly profitable, recession-proof product, plus a reputation for offering generous dividend yields to investors.

In fact, according to Wharton professor Jeremy Siegel, Altria Group (MO 1.6%), the domestic maker of the Marlboro brand, was the best-performing stock on the market from 1968 to 2017 when including reinvested dividends. The cigarette maker's annualized average return was 20% during that time.

Overview

Tobacco industry overview

Today, however, tobacco companies face a new set of challenges. Smoking rates have steadily declined worldwide, especially in the U.S., due to health concerns and increasing regulations. As a result, the industry has sought to pivot to next-generation products.

These include e-cigarettes, vaporizers, and chewable nicotine pouches, which circumvent some drawbacks of smokable cigarettes, like unwanted odor, and are perceived by some as better for your health. Some companies have looked beyond tobacco, partnering with cannabis businesses to capture the potential growth in an industry that bears many similarities to tobacco.

Tobacco stocks come with a number of risks, including increased regulation and declining smoking rates. Revenue and profit growth have been slow across the industry, but these stocks still appeal to investors because their profits and dividends have been so reliable, and profit margins are still strong. Investors are hopeful that next-generation products will eventually catalyze stronger growth.

A wave of consolidation in the industry has left just three major players in tobacco: Altria, Philip Morris International (PM 1.68%), and British American Tobacco (BTI 0.31%). With few competitors, these companies have been able to raise prices to generate more profits, even as cigarette sales volumes have fallen. Investors may also want to consider some of the smaller stocks, such as Imperial Brands (OTC:IMBBY) and Vector Group (NYSE:VGR).

Most of the discussion around tobacco stocks focuses on traditional cigarettes and next-generation products, but it's worth noting that these tobacco companies also sell smokeless products, such as chewing tobacco, in addition to cigars, pipe tobacco, and accessories like rolling papers. Keep reading to learn more about some of the top tobacco stocks.

Top stocks

Top tobacco stocks in 2024

1. Altria Group

The domestic manufacturer of Marlboro, Parliament, and Virginia Slims split from Philip Morris International in 2008. However, it still owns Philip Morris USA, the subsidiary that oversees Altria Group's cigarette brands.

Almost all of Altria's sales come from the United States, where smoking rates have steadily declined over the past generation. According to the Centers for Disease Control and Prevention, the percentage of U.S. adults who smoke tobacco fell from 21% in 2005 to 11.5% in 2021.

Unsurprisingly, Altria's cigarette sales volumes have slipped, too. In 2023, its cigarette sales volume declined by 9.6% to $76.3 billion. In the first half of 2024, cigarette sales continued to decline, falling 13% to $34.3 billion.

The long-term decline in tobacco smoking explains why Altria has taken steps to diversify away from traditional cigarettes, most notably taking a 35% stake in e-cigarette manufacturer Juul Labs and a 45% stake in Canadian cannabis grower Cronos Group (CRON 4.28%). In 2023, it acquired e-vape company NJOY Holdings for $2.75 billion.

However, those investments haven't played out as investors had hoped. In December 2018, Altria paid $12.8 billion for partial ownership of Juul. Still, after regulators forced Juul to stop making most of its flavored cartridges and questioned its marketing tactics, the e-cigarette company's valuation fell significantly.

In 2022, after several write-downs, Altria ended up exchanging its entire stake in Juul for heated tobacco intellectual property rights valued at $250 million. The same month that Altria took a stake in Juul, it acquired 45% of Cronos Group for $1.8 billion and made the company its exclusive partner for cannabis. However, as of September 2024, the value of its stake was down by more than 75%.

Altria is now staking its next-gen strategy on NJOY, which sells both single-use vapes and pods that work with reusable devices. So far, NJOY is delivering solid growth, although it still makes up a negligible part of the business. In the second quarter, NJOY's consumable shipments increased 14.7% to 12.5 million units, and device shipments jumped 80% to 1.8 million units.

Despite the difficulties it's faced in diversifying away from cigarettes, Altria Group remains a dividend powerhouse. It has raised its dividend 59 times in the past 55 years, effectively making it a Dividend Achiever, an unofficial status due to its spin-off history. (Dividend Achiever is a trademarked property owned by Nasdaq.)

Management has set a target payout ratio of 80% of earnings per share, knowing that its dividend is the main reason shareholders own the stock. As of September 2022, its dividend yield was an attractive 7.6%, and it paid a dividend of $1.02 per quarter.

2. Philip Morris International

Altria has looked outside the company to diversify and cushion itself from the decline of cigarette sales. However, Philip Morris is pursuing more of an in-house strategy.

The company -- which sells many of the same brands as Altria but outside the U.S. -- has pinned its hopes on heat-not-burn (HNB) tobacco products. Its primary offerings in this category are the devices and cartridges sold under its IQOS (widely believed to be an acronym for "I Quit Original Smoking") brand.

While the HNB process is similar to the process used by vaporizers and e-cigarettes, devices such as the IQOS use tobacco rather than the liquid made for vaporizers. By staying focused on tobacco, Philip Morris is taking advantage of the same supply chain for IQOS that it does for traditional cigarettes while also enjoying attractive profit margins for IQOS cartridge sales.

The company claims that HNB devices are safer than regular cigarettes because they don't burn tobacco. However, the science is still being debated, and the Food and Drug Administration (FDA) has not concluded that HNB devices are safer than cigarettes.

The strategy does seem to be successful since almost 40% of the company's revenue now comes from smoke-free products, and IQOS is gaining market share in countries where it's available. Additionally, its 2022 acquisition of Swedish Match for $16 billion has been a success due to the popular Zyn chewable nicotine pouch.

After finding success with IQOS internationally, Philip Morris paid $2.7 billion to acquire the rights from Altria to sell the product line in the U.S. As of September 2024, Philip Morris was working on taking the product to market in the U.S.

Unlike Altria, Philip Morris posted a roughly 2.8% increase in cigarette sales volume in the second quarter of 2024. However, its sales volume of heated tobacco units (HTUs) rose 13.1% in that same quarter, indicating that devices such as the IQOS have strong growth potential.

As a dividend stock, Philip Morris does not disappoint. Since its split from Altria in 2008, the company has raised its dividend every year, and its dividend has increased by 183% as of September 2024. The stock also offers a healthy dividend yield of 4.2% of the share price. If its history as part of Altria were included, it would qualify as another Dividend King.

3. British American Tobacco

British American Tobacco (BAT) has also become a titan of the industry, fueled by its $49 billion acquisition of Reynolds American in 2017. Today, the company owns a range of popular cigarette brands, including Camel, Newport, Dunhill, Natural American Spirit, and Lucky Strike, as well as next-gen products, such as Vuse for vaporizing, glo for HNB smoking, and Velo nicotine pouches.

Like other tobacco companies, BAT is focused on substantially transitioning to next-gen products. In the first half of 2024, the company saw a 6.8% decline in cigarette sales volume to 250 billion. Nicotine pouches have emerged as the fastest-growing segment from new categories, with volume sales up 43% in the first half and revenue up 44% to 311 million pounds (about $411 million at current exchange rates).

However, the vast majority of its revenue still comes from cigarettes. The company had been targeting 5 billion pounds (almost $6 billion) in revenue from next-gen products by 2025 but said it was unlikely to get there in July due to a crackdown on single-use products in the U.S.

The advantage of investing in BAT over Altria and Philip Morris is that it provides exposure to the tobacco sector worldwide rather than just in the U.S. or just internationally. The company also sells a wide range of products, including cigarettes, vaporizers, chewing tobacco, and heated tobacco. Buying shares of BAT is the easiest way to gain portfolio exposure to the whole tobacco industry via just one stock.

British American also pays a generous dividend yield of 7.9%. Its high operating profit margin, which topped 45% on an adjusted basis in the first half of 2024, helps to ensure the dependability of the quarterly payout.

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Bottom line

The tobacco industry is evolving

Tobacco companies all face the same conundrum these days. Although selling traditional cigarettes is highly profitable, the business is in decline and is expected to keep declining. Tobacco companies need to find new ways to grow and diversify their businesses.

Investors may want to consider investing in a basket of tobacco stocks to gain exposure to different growth strategies and reduce risk. While income investors can still count on tobacco companies to deliver dividends, the path to growth in the industry is uncertain.