Forget Big Tobacco: A Hidden Gem for Dividend Investors

Charles Sizemore Economy and MarketsI follow income stocks pretty religiously, though I’ll admit it’s been a while since I’ve looked at tobacco stocks, which are some of the most consistent and well-known. I sold my last tobacco stock – Marlboro maker Altria – about a year ago when I took a long, hard look at the dividend yield (then about 4%) and decided it no longer made sense to own as an income stock. At that price, there was a lot of potential downside and very little upside.

Or so I thought…

Altria’s stock price has enjoyed a nice 20% bump since then, and the yield has shrunk to just 3.6%. The stock trades for 23 times earnings… which is a slight premium to the broader market.

Now, I’m not the biggest fan of bubbly tech stocks like Facebook or Amazon. But I can promise you this: I’d much rather pay the current multiple of 84 times earnings for Facebook or even 460 times earnings for Amazon… even though I consider those valuations to be wildly excessive… because I believe there’s at least a chance they could grow into those valuations.

It could happen. But tobacco stocks operate in an industry in terminal decline. Volumes for cigarette sales fall with every passing year, and the regulatory noose just keeps getting tighter.

Now, there’s nothing wrong with buying a stock in a declining industry, particularly if you’re playing it as a short-term trade. And even as a long-term holding, it can make sense so long as you’re buying them as deep-value stocks, and realizing a decent current return via an outsized dividend. But there is no scenario under the sun in which tobacco stocks should trade at a premium to the broader market.

None. Nada. Zip.

This is how desperate investors are for yield these days. They’re willing to accept a sub-4% yield on a no-growth company in a slowly dying industry because they can’t find a better yield elsewhere.

Well, the fact is, they’re not looking hard enough.

As I wrote two weeks ago, prices in several corners of the income market are actually downright cheap. Yields of over 10% are common in mortgage REITs and business development companies. (Incidentally, I recommended one of my favorite mortgage REITs in the last issue of Boom & Bust.)

These sectors are not without their risks, of course. Mortgage REITs borrow a ton of money, and investors are rightfully scared of anything with leverage right now. But the selling appears to have already happened, and for whatever risk is left, the current prices and yields are a fine compensation.

But while I like select mortgage REITs and business development companies, I see the very best opportunities in closed-end funds.

As a group, closed-end funds are trading at some of the deepest discounts to net asset value since the 2008 meltdown and its aftermath. It’s not unusual these days to find funds trading for 80 cents on the dollar. And some of the yields can be downright spectacular.

In the last issue of Peak Income, Rodney recommended a solid municipal bond fund paying a fat 6.7% yield… tax free. If you’re in the highest tax bracket, that amounts to a tax-equivalent yield of over 11%.

Now, getting these kinds of yields involves taking a modest amount of risk. The fund employs a little leverage and owns a small amount of bonds issued by some shaky issuers like Illinois and Puerto Rico.

But the vast majority of the fund invests in bonds whose state and local governments you can reliably expect to service their debts. And believe me, I consider a fund like this a lot safer than an Altria tobacco company trading at today’s prices.

Later this week I’ll be adding a new recommendation to the portfolio: a solid REIT fund offering an 8% dividend, and backed by some of the biggest, safest names in the business.

Charles Sizemore
Editor, Dent 401k Advisor

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Categories: Investing

About Author

Charles Sizemore is a research analyst with Dent Research. His primary research focuses on income, retirement strategies and fundamentals.