The way tobacco stocks have rallied this spring, it would be a nice to own a few shares of a tobacco...
The way tobacco stocks have rallied this spring, it would be a nice to own a few shares of a tobacco sector mutual fund. The stocks of Philip Morris and RJ Reynolds Tobacco Holdings both rose more than 50% from their early 2000 lows through 24 May.
If you had an index fund pegged to the Bloomberg US Tobacco Index, which includes those two companies plus smokeless-tobacco maker UST, you would have gained 7.7% on 15 May alone. The total return year-to-date is 33%, while the broad Standard & Poor's 500 Index has lost 4%.
Yet there are no tobacco funds among the dozens of specialised single-industry portfolios offered to US investors. Barring the most dramatic turn of tide since Exodus 14:21, there never will be. As Jim Grant put it so succinctly in his Grant's Interest Rate Observer early this year: "There is no future in smoking, neither for the smoker nor for the tobacco companies.''
Plenty of fund managers who invested in this once-reliable growth industry know what he is talking about. A 55% drop in Philip Morris shares in 1999 played havoc with the returns of 'value' funds like the Oakmark Fund, which changed managers in early 2000, and the Kemper Dreman High Return Fund. Oakmark declined 10% during the year and Dreman High Return lost 13%, while the S&P 500 gained 21%. Socially responsible funds received a big boost towards beating the S&P 500 simply by owning no Philip Morris or any other tobacco stock.
Many fund managers have been busy lately extricating themselves from their Philip Morris holdings. In the latest Bloomberg Analytics tally, institutional sellers of the stock outnumbered buyers by about a seven to five ratio. Fidelity Investments, the giant of the fund industry, has in recent months reduced its aggregate Philip Morris holdings from about 7% of the outstanding shares to less than 5%, according to its public filings. Among the 36 stock funds profiled in the May issue of Fidelity's monthly guide to its fund family, not one lists Philip Morris as a top 10 holding.
Philip Morris, which constitutes more than half of the Bloomberg US tobacco index, was long revered as a standout growth company, bringing in strong earnings not just from Marlboro cigarettes and other tobacco products, but from dozens of non-tobacco stalwarts such as Kraft cheese and Maxwell House coffee. Through the 1980s and most of the 1990s, its stock averaged a 25% annual return. In the past five years, it has maintained dividend growth at a 12% rate, while buying back shares as well.
However, lately it has morphed from a growth stock into the type favoured mainly by contrary-minded bargain-hunters. "While it is no doubt a well-managed company with attractive valuations, it is equally certain that its stock is a risky proposition,'' says Scott Cooley, an analyst at Morningstar in Chicago.
The transformation became official a few months ago when the stock's dividend yield surpassed its price-earnings ratio. Even after the stock's recent rally, the P/E, at about 7.8 times this year's estimated earnings, barely exceeds the yield, at 6.7%. "A very cheap stock,'' said Grant, "if one is prepared to overlook the risk of oblivion- through litigation, which one cannot.''
Despite all its baggage, some conservative funds have not given up on Philip Morris yet. It still shows up among the latest monthly top 10 holdings at three Capital Research Management funds: Investment Co of America, Income Fund of America and American Balanced Fund.
Managers of these funds look at the stock as they would an attractively priced junk bond, whose high yield and intriguing possibilities they see as outweighing the constant risk of an unhappy surprise.
Note, though, that all three are highly diversified, owning between 180 and 350 securities apiece. In each case Philip Morris is no more than 1.5% of total assets. That diversification cushions them against whatever misadventure the stock might encounter next.
Chet Currier in the Bloomberg New York newsroom
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