Many people are looking for investments that generate passive income – assets that bring them cash on a regular basis, hopefully in growing amounts over the years. You can generate passive income from your stock market investments by purchasing shares of companies that pay dividends. The problem is that most stocks these days have pretty meager dividends, or don’t pay them at all.
This point is illustrated by the average dividend yield for stocks in the broad market S&P500 index is only 1.35%. If you want more passive income, you might be better off buying short-term U.S. Treasury bonds or parking cash in a high-yield savings account. To build a passive dividend portfolio, investors should choose individual stocks with sustainable and high dividend yields.
Two stocks with a high dividend yield are today Altria Group (NYSE:MO) And Philip Morris International (NYSE:PM). Both are tobacco giants and, funnily enough, used to be part of the same company. One share yields 8.6%, the other 5.2%. But what’s a better passive income game?
Altria Group: High yield from traditional tobacco
Altria Group owns Philip Morris USA, a leading tobacco/nicotine company in the United States. Tobacco stocks have been among the strongest performers in the market in recent decades, due to the large cash-generating power of the cigarette sector. The company has faced declining sales volumes in the cigarette sector, but has countered the impact by steadily increasing cigarette prices. Last quarter, Altria management estimated that the domestic cigarette industry’s total estimated volume fell 9% year over year. But Altria’s revenues, excluding excise taxes, fell only 2.2% year over year.
The combination of price increases and volume decreases has led to consistent profit growth. Free cash flow per share has grown by 122% over the past ten years. One of the driving forces for this is Altria’s share buyback program, which promotes free cash flow per share. The number of shares outstanding has fallen 13.4% over the past decade, and the company has accelerated its buybacks in recent quarters.
Companies like to tap into free cash flow for dividend payments, and this has fueled the growth in payouts to Altria’s shareholders. Currently, the annual dividend payment is $3.88 per share, well below the trailing free cash flow of $5.09 per share. That dividend yields a tasty 8.6% at the current share price.
Philip Morris International: Growth in new nicotine products
The international part of the Philip Morris operation is, unsurprisingly, owned by Philip Morris International. The company sells cigarettes and tobacco products almost everywhere except the United States. However, unlike the Altria Group, Philip Morris is not experiencing massive volume declines in its cigarette business. Last quarter, sales volume of combustible fuels shrank by only 0.4% year-on-year.
In addition, Philip Morris International is the leader in new technology nicotine products. It owns the top brand of heat-not-burn tobacco, Iqos, which is growing like wildfire in Europe and Japan. In the United States, the company has the nicotine pouch brand Zyn, whose volumes have grown to 443 million cans in the past 12 months from virtually zero six years ago. These developments caused total shipping volume to increase by 3.6% last quarter, and revenue to increase by 11% due to price increases.
The company currently pays a dividend of $5.17 per share, which is only slightly lower than its free cash flow of $5.76 per share. This narrow gap is something income investors should keep in mind. At current share prices, the stock dividend yields approximately 5.2%.
Which dividend stock is the best?
Altria and Philip Morris International both have positives and negatives for income investors. Altria has a higher yield and more room to increase its dividend, based on its free cash flow numbers. However, the company is facing faster volume declines in the US market.
Philip Morris International pays a smaller dividend and has little room to grow it on a free cash flow basis. Despite this, I think Philip Morris International is the better stock to buy for dividend investors in the long term. Sales of new technology nicotine products are growing rapidly and should generate healthy cash flow for Philip Morris in the coming years. Cigarette consumption outside the United States is also much more sustainable, which could lead to better sales and profit growth. This combination should lead to faster dividend growth for Philip Morris International in the long term.
Altria Group should do well for investors over the next five to 10 years. But the better passive income bet that you can “set and forget” in your portfolio is Philip Morris International.
Should You Invest $1,000 in Altria Group Now?
Consider the following before purchasing shares in Altria Group:
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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 Stock Return 8.6% vs. 1 Stock Return 5.2%: Which is Better for Passive Income Investors? was originally published by The Motley Fool
