Investors like dividends for their sustainability and stability during volatile markets. As anyone who has paid attention to the past five years knows, we have seen some pretty volatile markets (both up and down). Steady dividend payments can help you weather the volatility storm.
But what should an investor do if the S&P500 only pays an average dividend yielding 1.32%? That’s not much annual income and significantly worse than the returns you can currently get from short-term government bonds.
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Investors should look for stocks with a high starting dividend yield and that also have the earnings growth to push these dividend payments higher year after year. These stocks are scarce and the market is at record highs.
One share that meets this criterion is Philip Morris International(NYSE: PM). This misunderstood nicotine giant is posting strong revenue and profit growth and currently has a dividend yield of over 4%. Here’s why this dividend growth stock could outperform the S&P 500 over the next decade.
Philip Morris is mainly understood as a seller of cigarettes outside the United States, with brands such as Marlboro and Chesterfield. This is not the complete picture of the current company and has not been the case for years.
Through internal investments and acquisitions, the company has significantly expanded its business from cigarettes to heat-not-burn tobacco, electronic vapor and nicotine pouches. These are known to be less harmful ways to consume nicotine and have been gaining market share over cigarettes for over a decade now, with Philip Morris leading the industry in this shift.
Last quarter, these new nicotine products made up 38% of the company’s total sales and are growing faster than the consolidated business. Strong growth of Zyn nicotine pouches in the United States and Iqos heat-not-burn devices in Europe and Japan helped Philip Morris’ smokeless division grow 16.8% year-on-year in sales last quarter. Gross margin improved due to greater scale, leading to gross profit growth of 20.2% for the segment.
If these products take over the nicotine market in the next decade or two, they could drive sales growth for many years into the future.
Don’t sleep on the old-fashioned cigarette business for Philip Morris International. Consistent price increases have allowed the company to grow its revenues from this segment for quite some time.
Total cigarette prices for the company have increased 5% or more per year in 2022, 2023 and so far in 2024. This is why cigarette sales grew 8.6% last quarter.
I suspect that Philip Morris will be able to grow cigarette sales for a long time through price increases. But even if nicotine consumers suddenly quit smoking due to price increases, the company will be able to retain these customers with its leading nicotine pouches and heat-not-burn brands (Iqos and Zyn). This is a robust strategy that will allow Philip Morris to benefit from whichever direction the nicotine industry moves.
At the time of writing, Philip Morris has a dividend that yields 4.4%. It currently pays a dividend per share of $5.25, which is easily covered by its $6.46 in free cash flow per share. Both figures have risen steadily over the past decade, and I suspect they will continue to do so in the next decade.
With the rapid growth of new nicotine devices, sales should grow at least 5% to 10% per year over the next five years. Add to that the expansion of profit margin through greater scale and I think free cash flow per share can grow above 10% for a long time. This means that management has the option to increase the dividend per share by 10% annually.
The calculations in this scenario look favorable for investors who hold on in the long term. If Philip Morris’ dividend per share is 10% per year for ten years, the dividend yield will increase to 11% in ten years. That’s compared to the current share price of $124. In this scenario, the stock is also likely to be higher, meaning investors will appreciate the dividend income and stock appreciation as they build their wealth by owning these stocks.
This combination is the beauty of buying dividend growth stocks, and why Philip Morris International will crush the S&P 500 index over the next decade.
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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool recommends Philip Morris International. The Motley Fool has a disclosure policy.
1 Great Dividend Growth Stocks That Could Outperform the S&P 500 Originally published by The Motley Fool
