Recent Sale

brokenpiggybankI don’t sell stocks often, so it’s always a bit tough for me to write these articles. I look at each position in my portfolio as essential branches to my dividend tree, where every branch produces fruitful dividends which will eventually provide the income I need to pay my bills. And I eventually want at least 50 such branches on my tree so that if one branch becomes unhealthy the tree continues to thrive. So selling is something I try to avoid unless absolutely necessary, because it means my tree is becoming smaller. However, if the occasional pruning makes the tree stronger over the long haul then I consider it a wise chore to perform.

This is the eighth such article I’ve written since I went live with this blog in early 2011. They don’t come up often, but I always try to provide a reasonable and sound case for my actions, and will attempt to do so once again here.

I sold 50 shares of Lorillard Inc. (LO) on 5/7/14 for $58.74 per share, for a total net sale of $2,929.94 after commissions.

Lorillard, Inc. is a tobacco and cigarette manufacturer, which markets and sells its products in the U.S. Its brands include: Newport, Kent, True, Maverick, and Old Gold. It is the third largest cigarette manufacturer in the U.S., and also has significant exposure to e-cigarettes through its subsidiary blu.

This is a reduction of a position rather than the outright elimination, as I still own 50 shares of Lorillard. So I reduced my exposure to Lorillard by selling off half of my position here.

I wrote an article a few years ago in regards to my view as to when to sell a dividend growth stock. Basically, I view only three circumstances which would warrant a sale: changing fundamentals, a static or reduced dividend, or a gross overvaluation. Looking back on this article, and applying what I’ve learned as an investor over the past four years, I would probably add another reason to that list: risk reduction. Managing risk is an important part of ongoing portfolio management, and my strategy here has usually been to build other lower-risk positions around my higher-risk plays in order to accelerate around risk and keep positions weighted appropriately according to my risk profile. However, LO’s recent stock price run, coupled with what I believe to be a more aggressive stance by regulators, forced me to look at reducing risk directly here by selling off part of my position.

While Lorillard’s dividend growth has been positively impressive since I initiated a position back in October 2012, I’ve become concerned about the possibility of increasing regulation around its core product, which would obviously affect the fundamentals negatively. In addition, the share price performance over the last few months has given me the opportunity to reduce my risk by realizing significant capital gains and investing that capital elsewhere.

My main concern with Lorillard here is the possibility of greater regulation in regards to the manufacture and sale of menthol cigarettes in the U.S. And since Lorillard receives approximately 90% of its revenue from its blockbuster Newport Menthol offerings, this would be a major blow to the company. The FDA has the authority to regulate menthol cigarettes including harsher restrictions and/or an outright ban. While I think an outright ban is unlikely due to the backlash, lost of tax receipts, and potential for black market products and illicit trade, the language the FDA uses regarding menthol cigarettes appears aggressive to me.

Specifically, the FDA initiated an independent scientific evaluation regarding the impact of menthol cigarettes on society and concluded:

…adequate data suggest that menthol use is likely associated with increased smoking initiation by youth and young adults. Further, the data indicate that menthol in cigarettes is likely associated with greater addiction.

Now, I’m no expert on the FDA or broader government regulation. However, this language does seem to suggest that there is at least a chance that some type of increased regulation could be coming down the pipeline at some point. It’s impossible to say exactly when/if the FDA might take action, but because the risk is simply there, and my dividend income is going to fund my lifestyle in the future, I felt it appropriate here to take action of my own.

However, it wasn’t just the possibility of regulation that forced me to take a look at selling off part of my stake in this tobacco company. After all, the risk of increased regulation is nothing new in the tobacco industry, and certainly not for Lorillard as they’ve been dancing with the FDA for years now.

Rather, shares have had quite a run-up over the last few months as rumors of a potential merger with Reyonlds American Inc. (RAI) have continued to persist. It’s hard to say what’s going to happen here as there is a ton of moving parts – British American Tobacco Plc (BTI) is the largest shareholder in RAI – but I felt it appropriate to take a fresh look at the valuation of shares after this kind of pop.

LO shares are trading hands for a P/E ratio of 19.22 right now, which is well over the five-year average of 14. The yield on shares, at 4.22% based on my sales price, is also much lower than the average over the last five years of 4.8%. However, I also performed a Dividend Discount Model on shares, using a 10% discount rate and a 6% growth rate. This gave me a fair value on shares of $65.19, which is well over the price at which I sold. I think the growth rate is fair because it’s well under the projected three-year growth rate in EPS – at 9%, according to S&P Capital IQ. It’s also well under the 10-year growth rate in EPS (13.1%) and five-year growth rate in dividends (29.1%). However, I also feel that one would want a very large margin of safety on shares here due to the potential of increasing regulation on menthol cigarettes and shrinking demand for cigarettes in general here in the U.S. Basically, shares in LO are usually undervalued by a large margin due to uncertainty in the industry and a shrinking customer base, but that discount is slowly disappearing as the share price advances.

Overall, I still feel Lorillard is an attractive investment at today’s prices, which makes it probably appear odd I sold. However, I didn’t completely eliminate my position. I rather just cut it in half, which reduces my risk significantly. In addition, I wanted to reduce my exposure to the tobacco industry as a whole, as before this sale I had an ~11% allocation to cigarette manufacturers through my investments in LO, as well as Altria Group Inc. (MO) and Philip Morris International Inc. (PM). Tobacco manufacturers are historically wonderful investments due to a combination of chronic undervaluation, high yields, and addictive products. However, as shipment volumes continue to decrease across the world, and more specifically developed markets like the U.S., I felt it made sense to reduce my exposure a bit here.

My cost basis on these shares was $1,940.65, as part of a lot of shares I purchased in October 2012. In addition, I’ve received $177.25 from these 50 shares during my time of ownership in the company. That means my total return on these shares is 60.1%, which is obviously quite attractive over a period of just 19 months.

I would have preferred just to leave the entire position be, but I honestly felt a little uneasy about both my exposure to tobacco in general, and my exposure to a company that receives such a large percentage of its revenue from a product that could face unfavorable attention from the FDA. My view is that the less one sells and handles a portfolio the better, but I also feel that one should be prudent when faced with changing environments.

I’m keeping the other 50 shares because the valuation still seems relatively attractive, and the company is still growing at a robust clip. Earnings, revenue, and dividends are all growing appreciably, and they still have a 45% dollar market share on the fast growing e-cigarette market through its investment in blu. Furthermore, they continue to gain market share in traditional cigarettes, recently reaching a 15% market share of the entire U.S. cigarette market for the first time ever, with a 13% market share for Newport. And if menthol cigarettes are indeed more addictive, and the FDA continues to stay passive, this gives Lorillard a significant economic moat around its product. Furthermore, they have seven consecutive years of dividend growth under their belt after being spun off from Loews Corporation (L) in 2008. And their dividend growth has been most impressive, as I discussed earlier. I think high-single-digit dividend growth is very likely for the foreseeable future.

I’ve already reinvested this capital into another company, so be sure to stop by over the coming days to read about that! I’m excited about these transactions, and feel that I’m able to sleep just a tick better at night, which is priceless.

This transaction reduces my dividend income by $123.00, based on the current quarterly payout of $0.615 per share.

My portfolio still holds 46 positions after this sale, as this was a reduction of a position rather than an outright elimination.

And just like I do when I announce purchases, I’m going to include some analyst valuation opinions on this stock.

*Morningstar rates LO as a 2/5 star value, with a fair value estimate of $45.00.
*S&P Capital IQ rates LO as a 3/5 star hold, with a fair value calculation of $53.40

I’ll update my Freedom Fund in early June to reflect my recent sale.

Full Disclosure: Long LO, MO, PM

What do you think? Was it prudent to reduce my LO holdings here? Should I have done nothing instead? 

Thanks for reading.

Photo Credit: Stuart Miles/FreeDigitalPhotos.net

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58 Comments

  1. Interesting move, DM.
    I have stayed away from the tobacco stocks as I think that there will be more roadblocks placed in the coming years for the manufacturers. Yes, they are addictive products but there is a consensus from every department of government, medical community and soceity in general that there are absolutely no benefits associated with smoking. We are already starting to see some roadblocks placed around the world – bans on advertising, plain packaging, graphic packing laws, taxation etc. I will be staying away from these stocks.

    Now, if I have to invest in somethign just as addictive, but is tolerated and almost encouraged by everyone – I would invest in coffee 🙂

    regards
    R2R

  2. Nice Article.
    Maybe in the next article you can go into detail about how you allocated the proceeds from this sale? Do you have a process of first going thru your current holdings and looking where to add? Do you maintain a short list of watch stocks that you rank to allocate new capital to? I have a portfolio of 15 dividend stocks, and maintain a watch list of about 20 or so I would like to add if the price/ timing is right. But currently I don’t have a good process of picking between adding to an existing position or buying a new position. Thanks!

  3. Good move!

    I also sold some LO to reduce my US tobacco exposure recently as well. Unfortunately I sold it on the first pop with the merger rumors around 54-55. I still have a position though.

  4. DM,
    I looked at LO in the upper 40’s and didn’t pull the trigger. Man, it really shot up in the past 3 months due to the merger talks. Now I can’t justify buying after such a rise. Bought some PM instead. With 46 holdings you could go either way on this one in terms of lowering risk. Helps, but not a huge impact. My hunch is you’ll see it lower at some point to buy back if you decide later on you want your 50 shares back.
    -RBD

  5. DM,

    I sometimes wrestle with the concept of dividend investing. I am totally on board with buying assets that pay dividends, which in turn partially removes the speculation component from your buy and sell decisions. However what do you do when a 3% yielder moves 50% in six months or even a year. If you have $1500 invested do you take the $750 in profit or wait and collect $45 a year in dividends?

    DLR is a company I bought last year around $44 and is now at $59. I don’t believe this company is the next PG, KO, CLX, MCD, etc., so do I take the 35% gain for six months and buy a wide moat company? Sometimes I actually feel better with companies that slowly appreciate so I don’t worry about leaving a profit on the table. Maybe you can or have already written an article about the psychology of when to buy and sell a company based on rapid price movements.

    MDP

  6. Hasn’t stopped tobacco stocks or dividends from marching higher. That is.. despite oppressive regulation.

    Mind you i dont like them but i’ll happily defend peoples right to smoke them and collect the dividends after the government collects it’s share. Did i mention they aren’t going to go away anytime soon because those same governments collect MASSIVE taxes from them?

    http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=403

  7. I don’t own any tobacco stocks currently, but I’ve been watching and reading about Vector Group (VGR). They appear to be divesting more and more of the company into real estate lately to increase revenues and makeup for loss in tobacco sales. Interesting combination of business models. I’ll keep watching the sector for opportunities.

  8. R2R,

    I hear you on tobacco. They are very controversial stocks, to be certain. However, I support adults’ rights to use legal products, and I don’t mind profiting from that. However, I do agree with you that the writing is on the wall. I think the next 20 years for tobacco sure looks a lot worse than the last 20, and as someone who’s interested in the very long term, this concerns me. I think the next 5-10 years should be fine for most of the major players, especially if they start to consolidate, but looking past that is murky. And you’re right in regards to regulation picking up. This is exactly why I want to limit my exposure. The Australian plain packaging is a great example of what’s going on right now across the world.

    Coffee is a great alternative. I would also argue beer and spirits is the closest cousin. And that’s an area I don’t have exposure too, other than Altria’s stake in SABMiller. SBUX, BUD, and DEO are good plays here for that, and I hope to be invested in at least one sooner rather than later.

    Cheers!

  9. Joel,

    I definitely plan on revealing where the capital went with the next article. It’s still in the consumer space, but somewhere I felt offered more visibility and less risk over the next 20 years.

    I do maintain a watch list, and maybe I’ll go through that soon. I typically publish at least one article per month going over what’s on my watch list. I usually maintain about 20 stocks or so on it at any given time. There’s not much out there that’s attractive right now, but I continue to invest because I know these companies will surely be pumping out more dividends in a decade or so.

    As far as selecting a new investment vs. a current investment, this all depends on your weighting and what you’re looking for. Some investors prefer a more concentrated portfolio of 10-20 stocks, and as such will frequently add to what they’ve got. I prefer a portfolio of 50 or so stocks, and as such I’m at liberty to choose from a variety of companies at any given time. It just really depends on what you’re comfortable with as far as diversification, and then what’s attractively valued at the moment.

    Best wishes!

  10. fiveoh,

    Thanks! Glad you’re feeling me on this one. 🙂

    I thought about selling there at that level, but then took a look at the valuation and thought it was still pretty attractive, all things considered. After it hitting almost $60, however, the margin of safety, in my opinion, was disappearing. And my valuation puts it far higher than M* or S&P Capital IQ. I think a case could be made that it’s attractive up until $60 for the long-term investor, but I think that’s all the money here. We’ll see what happens. It may merge with RAI and we may see another pop depending on what’s negotiated. It may die down and go back to the high $40s. It may stay where it’s at for a while. I’m happy with any of those scenarios as long as I get to keep collecting that hefty dividend. 🙂

    Cheers!

  11. RBD,

    Yeah, I wouldn’t be interested in buying any here either. And I’m not saying that because I’m a seller. I still have a position. Rather, I think this is pretty close to full value for the stock, all things considered. I put a conservative growth rate on it, but looking out over the long term you have to wonder what happens to traditional cigarettes and whether they can make up for that via blu and other opportunities. They have a large market share in e-cigs, but that will surely diminish with time as new market participants enter the fray.

    I think you made a great call with PM. I have a much larger position in that company because it’s so much better diversified across markets. LO is strictly in the U.S. with traditional cigarettes (blu is expanding internationally), so that means any regulation has a far harsher impact on them.

    Thanks for the tweets, by the way! 🙂

    Cheers.

  12. MDP,

    I have an article sketched up on this. My take on is that if you think the company is still sound, not grossly overvalued, still raising dividends, and the risk is appropriate for you, then why sell? I’m personally not worried about realizing 40% or 50% gains – I’m more concerned with the 100%, 200%, and 300% unrealized gains that will surely start to occur over decades. The stock price has nothing to do with the company’s fundamentals. In the end, I look at the businesses not the stocks. I only sold part of my Lorillard stake because, as an owner, I’m concerned about regulation coming down the pipeline and harming my profits. This may or may not come to pass, but the risk is large enough to be worrisome for me.

    Just my take on it! Hope that helps. 🙂

    Cheers!

  13. Zol,

    I’m with you. I fully support one’s right to smoke, or do anything else legal. However, that doesn’t mean everyone feels the same. It’s important to keep that in mind and manage your investments appropriately.

    As far as tax income goes, I wonder how that compares with the money that the government spends on health concerns as it relates to disease as an effect from smoking? I should look into this. They might be receiving hefty revenue, but I wonder how much of it goes back out via healthcare spending as people get sick from smoking? Interesting topic.

    Thanks for sharing!

    Best wishes.

  14. luckydog17,

    I looked at VGR a long time ago and I didn’t like it. I can’t remember off the top of my head what the issue was, but it just didn’t make the cut for me. Maybe I’ll take another look. I just now checked the stock and it’s way down today. That’s a very interesting mix – tobacco and real estate. Interesting and weird all at the same time.

    I think the best way to play tobacco is in the branded manufacturers, however. There’s a moat there, whereas producers are just offering a commodity.

    Best wishes!

  15. I usually avoid tabacco stocks because tabacco usage is getting lower over time and almost all the governments are tightening regulation and increasing tax on tabacco products. So, for your health and your financial health stay away from tabacco and the stocks. 😀

  16. I’m struggling with the same issue myself. I bought AAPL in April 2013 around $440/share, and it’s now close to $590 (34% gain excluding dividends, ~37% including them).

    I set an initial target of $600 to either sell or cut my position, and to hold and take the cash flow if it did not. Looks like I need to be true to my word and sell out/cut my holdings soon. I like the mountain of cash they are sitting on, but it’s a huge bet.

    I’m really struggling here, but glad to have this problem!

  17. Tough issue. My third best holding is MO for the past 2 years (entered at $29 and it’s now around $40, plus dividends along the way).

    As of now, I plan to hold so long as cash flows remain positive, and earnings stay strong due to MO’s other businesses.

    I think there is more upside than downside from here, and I really doubt it will go below my basis of $29.

    As far as LO, I agree with the sell. The risk/reward doesn’t hold as strongly from today into the future. The biggest thing going for MO is the position in Miller, potential of e-cigs, and hopefully the remaining cash flow from tobacco over teh next 10+ years.

  18. Jason, I just stopped by to see if you had a great birthday. Hope you did. 😉

  19. I would not have touched this position. As a fairly priced stock with incredible dividend growth I believe the “chatter” about FDA regulation and taxes are greatly exaggerated. Government has been fighting big tobacco for 4 or 5 decades and all the while the major players in the industry continue to thrive despite regulation and taxation. As long as the numbers are good, PE, cash flow, dividend, dividend growth…. why sell?

  20. S Arun,

    That’s admirable, and I can’t say I blame you. Nothing wrong with avoiding certain stocks, and that’s what makes it a market. There’s always a buyer and a seller, right? 🙂

    However, tobacco stocks are some of the best investments over the long haul. But I see that changing in the future as the secular decline in tobacco usage continues. I think they’re still fantastic investments here, but one should monitor changes closely.

    Best wishes!

  21. Ravi,

    I wish I would have jumped on Apple back when it was below $400. I just felt uneasy about a tech company focused on consumer products. Reminds me of an HP or something, and you have to constantly innovate to stay ahead. But they’ve been very shareholder friendly with major buybacks, a split, and a nice dividend raise. I wonder about this company for the long term, but you can’t ignore the fact that they have very loyal and enthusiastic customers. For now, at least.

    And you’re right: First world problems are good problems to have. 🙂

    Best regards.

  22. Ravi,

    Overall, I’m very happy with my tobacco holdings. All have performed fantastically. And I hate to lighten the load here, but I can sleep a little better now. Even if my new investment provides slightly less returns over the next 5-10 years, I’m confident that I made the right move looking out over the next couple decades or so.

    I think MO is a great company, and their diversification, even after spinning off KRFT and PM, is mighty impressive. And I hope their new e-cig partnership with PM works out well for both parties.

    Thanks for the support on the sale. I wrestled with it for an entire day or so, but ultimately felt that I’d better with a little risk reduction.

    Cheers!

  23. KeithX,

    Thanks so much! 🙂

    I had a WONDERFUL birthday. My girlfriend took me out to a small little dinner so we could enjoy each other’s company. And then today I went to work and my last week got shortened by three days. So I’m now free as a bird! I now have The Beatles song stuck in my head.

    I’m just super excited for the new challenges and opportunities ahead.

    Appreciate the thoughts.

    Best wishes.

  24. DivHut,

    Well, I still hold the other 50 shares, so I’m hopeful LO continues to perform in a stellar manner. I’ve certainly been a happy shareholder.

    Again, it’s all about risk management to me. Is this a riskier play than, say, a KO, PEP, or a JNJ? I think so, but others may disagree.

    As far as menthol regulation, I would agree it’s unlikely. However, our government has made some boneheaded moves in the past, and I think it’s likely they’ll continue to do so in the future. I remember a lot of people talking about how unlikely the plain packaging mandate was in Australia due to the questionable legality, hardcore lobbying, and potential loss of tax revenue. Of course, we see how that turned out. I’m not comparing that situation to menthol regulation here, but I could realistically see a day when menthol is regulated heavier than it is now. Again, I hope that’s not the case and I hope LO continues to run. I’d just rather not make a big bet on it either way. In addition, there’s the long-term secular decline in smoking, so I’d rather just limit my exposure to tobacco in general. I’ve seen some investors with massive positions in MO and PM, and I just wouldn’t personally feel comfortable with that because of the trends. But to each their own.

    Best regards!

  25. Regulation does make tobacco stocks more risky, but the possibility of more regulation also makes the moat that the big players already have grow from huge to ENORMOUS!!

    Bad coupled with good, but the real question is how more tobacco could help your portfolio. In your case, high single digits is still plenty to share in the upside, but a little conservative in case things don’t stay so rosy.

  26. Hi Jason,

    I know what you mean regarding overall tobacco exposure – I am at around 15%, which is simply too high. But the regular and high dividends are tempting and tobacco shares were, a few years ago, very cheap. It will be interesting to see how this one pans out – all the analysts are predicting consolidation in this sector, although British American buying RAI looks like it could be the first move.

    FI

  27. “However, I support adults’ rights to use legal products, and I don’t mind profiting from that.”
    I’ve wondered about that from your portfolio. You have some holdings – tobacco companies – that made me interested in whether you were concerned about ethical investing. You support adult’s rights – but what’s your stance about industries or companies that take advantage of adult and child labour – flaunting labour rights, industries that abuse animals etc, or are profiteering to the expense of environmental factors. These are issues i’ve been thinking about. eg. Am i okay investing in a company that degrades the environment in order to make money now for shareholders – is shareholder value the only thing i care about?

  28. I hate smokers as much as the next guy but that is not going to stop me from making money from them! Philip Morris International, Inc.looking tasty right now !!

  29. I pulled the trigger on AAPL around 450$. I pretty much broke every rule i have in doing so and its the first time i did as such. I just have this hunch they are going to turn into a dividend stalwart and if im wrong they have boatloads of money to wait it out.

    I guess your allowed to throw the dart every now and then 🙂

  30. I agree with your point of allowing people who want to smoke – to smoke. No one should be told what they can or cant do.
    On the health front – as a resident of Canada, where we have public healthcare……I find it annoying that my tax dollars will be used for their treatment when they eventually get cancer and they should be made to pay upfront, which I think the extra taxing takes care of. Our 2014 budget hiked the taxes on tobacco products after freezing it for almost a decade.

    The alcohol stocks are very tempting as well….I want to pick up some DEO sometime soon.

    regards
    R2R

  31. Smart move. Whenever a stock reachs some sort of “irrational” valuation there is nothing wrong about taking a profit. I think you wish that to happen in one fo you holdings once a month, don’t you? 🙂 Besides there are many stocks around there to buy with yield and valuations very attractive.

    Cheers!

  32. Among those controversial stocks I own Phillip Morris and also Diageo. One could also argue on McDonalds if worrying about health is the point. On my Diageo position I’m pretty sure it will be one of my best bets on the long run. I made my particular analysis about it here http://www.dividendogma.com/analisis-de-diageo/

    Also I recently sold Intel (in january, after the dividend freeze). I think one has to be firm on your portfolio criteria. If one single stock is not performing as it is intended to do, take action. I do not say sell it completely, but take action and allocate capital somewhere else.

  33. FI,

    Yeah, tobacco stocks were great buys not too long ago. And I think PM still is to this day. However, you also have to be careful with allocation. Historically speaking, tobacco companies have been fantastic investments. But I think the secular decline in smoking doesn’t bode very well for them over the long term. The next 5-10 years might still be fine, but you have to think they’re going to hit a wall at some point to where price increases can no longer make up for a declining customer base. And seeing as how I’m investing for the next 30-40 years, this is something I’m cognizant of.

    We’ll see what happens with consolidation. I think at some point that’s going to have to happen, but I’m not sure if it’s now or not.

    Cheers!

  34. dee,

    Well, these are tough questions that only you can answer for yourself.

    However, I’ll just give you my quick thoughts on it. I think if you look hard enough you’ll find a drawback to any company/investment. All big businesses will naturally pollute, and some are worse than others. I’d have to really research child labor issues before I comment on that, but just to give you some quick examples: Oil companies? Pollution. Food companies? Obesity, animal rights, chemicals, etc. Health companies? Lawsuits, medications with severe side effects, etc. Defense companies? Death, injuries, war profiteers, etc. Banks? Making money off the less fortunate, etc.

    Of course, I’m exaggerating a bit here. And I’m picking out the worst in these businesses. But that’s just it. I try not to look at the drawbacks. I try to look at the benefits of energy for new middle-class societies across the world that now have electricity and transportation, defense of our country and way of life, access to capital markets which makes early retirement actually possible, cheap, easy, and tasty food, etc.

    There are always trade-offs in life. There is no free lunch.

    Happy investing!

    Best regards.

  35. Asset Grinder,

    See, I don’t really hate smokers. Of course, that’s just my opinion.

    Either way, I definitely don’t mind profiting off of another’s habit. And I agree that PM is looking pretty solid here. Of all the available investments in this space, this one is my favorite.

    Best wishes!

  36. Zol,

    You’re absolutely allowed to take some risks. I took one recently myself with TIS. If you have a stable portfolio chock-full of blue chips, then I see no reason to take a little risk once in a while, as long as you’re comfortable with it.

    Best of luck with Apple!

    Cheers.

  37. Trader,

    I don’t necessarily think the valuation on LO is irrational, but rather the traditionally large margin of safety in shares has largely disappeared. I’m not quite sure the value is commensurate with the risk here, but they could continue to surprise. I must say LO has been fantastic, and it’s the only domestic player still growing. But they’re going to face increasing competition in e-cigs and the secular decline in smokers will eventually hit their bottom line. It’s not if, but when.

    Take care!

  38. jguerrero71,

    I think DEO is a great pick. I haven’t looked at it in a while, but I should. That company would fit very well in my portfolio. I’ve looked at it in the past and the valuation/yield didn’t work for me, but I’d love to be a shareholder at some point.

    And I’m with you on INTC. I sold off in two lots as they continued to disappoint with the dividend. A token raise probably would have kept me on board, but no raise and no management commentary on the subject forced my hand. I’m happy with my decision.

    Take care!

  39. “the traditionally large margin of safety in shares has largely disappeared”, so, I say, is irrational to have such a large stake in that company 🙂

  40. Ideally, you would separate “investing” from “charity”.

    I do believe in the choice of the consumer. I suppose we all make that decision for each of our holdings. If I found out AAPL was paying bribes to gangs, organized crime, and customs, I probably would not be a shareholder even though I do love their products (I own a Mac, Iphone, and Ipad).

    It’s a personal decision, but I think that example shows that we all make the conscious decision. Also, it would be nearly impossible to agree with EVERYTHING a company does. Eventually, we all have to pick and choose.

  41. Agreed. I bet that one of three things could happens: 1) They become shareholder friendly and start paying a dividend, and increase dividends over time, 2) They would come back in favor and the stock price would rise after being beaten down from $700, 3) It could go the way of MSFT and trade sideways for the next decade, in which case I would just sit on my dividend and be happy.

    I was not particularly sold on the business, because consumer tastes change rapidly, and technology/hardware companies have to reinvent themselves more often than JNJ, KO, and the like.

    Overall, I figured at $440 (avg basis), there was more upside than downside, either through dividends or capital appreciation. Glad to see it paid off. Also, Einhorn believed in the stock.

    There aren’t many companies with the problem of “too much cash”, and I’m glad to wait and see if they figure it out. 🙂

  42. Agreed. I see INTC as more of a growth play than a DGI stock (though 3.5% yield is not bad).

    Tech/hardware/software/etc just has a short product cycle when compared to most other sectors, so the inherent risk is higher. INTC has a R&D advantage more than a patent advantage in being able to produce more dense chips than anyone else (at this time).

    Over time, however, I believe Intel/Qualcomm/other chipmakers will fare very well, given the overall world is headed toward further integration of technology in our lives.

    Price x Qty = Dividends

    The only question is, can the decline in price per unit be offset sufficiently by volume? Time will tell…

    I think it’s fairly well run, but we shall see.

    I bought in ~$21.50, and have set a target of $30 to sell/cut by 2015. I’ll reassess a new target to sell/cut for 2 years later in 2015 if it’s still sitting in the mid-20s.

  43. DM–

    You may already do this, but I’ve started setting and tracking price targets for each of my holdings for 2 yrs at a time.

    Example, I bought AAPL in 2013 at ~$440, and decided I would take the loss and sell if it went below $350 (assuming I felt it could not recover), and also would sell if the price hit $600 by 2015.

    I think setting a 2-yr price target for holdings is a good way for us to be more methodical about investing and to avoid selling/buying based on emotion. Also, setting a target gives us a way to take gains and reinvest elsewhere when the time is right.

    In general, the targets I’ve set are prices I think the stock has limited future upside, but of course we have to re-evaluate.

    You can’t win everything, but I’ll sure join you in trying! 🙂

  44. Trader,

    Can’t say I disagree with you here. However, I’m willing to hold on to an investment even when the valuation isn’t quite attractive, as long as the price isn’t grossly expensive. But with LO, I just felt the risk/reward relationship was skewed a bit negatively for me over the long term. We’ll see. I think it’s still a great company in this space. And I hope my remaining 50 shares continue to grow. 🙂

    Cheers.

  45. Ravi,

    I actually don’t set price targets like that. I think at that point you’re trying to outsmart the market, and I’ve never claimed to be any good at doing this. Rather, I just take a look at long-term trends in companies. I try to let them tell me their story, and if that story is good I then try to value the business as accurately as possible. If the valuation is attractive then I’m likely to buy. As long as the story remains true and the valuation doesn’t get out of control I’m likely just to continue holding. I plan on holding many of my investments for 30-40 years without selling. However, LO is facing significant headwinds with the secular decline in smoking, and thus their consumer base is slowly disappearing. This obviously doesn’t bode very well for them. They will likely do well over the next 5-10 years, notwithstanding a menthol ban. But while the valuation wasn’t out of control here, the risk/reward relationship, in my opinion, doesn’t favor me very much here. Now if this was a JNJ where I was more confident about their prospects over the next 10-20 years or more, I’d just hold. But with LO, they’re on the clock. I think they have less time to overcome a slightly unattractive valuation.

    Best wishes!

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  47. I have such a problem when deciding whether to sell. In my 3 or 4 years of dividend investing I have only sold a part of one position (MCY when it was peaking – http://www.myjourneytomillions.com/articles/sold-portion-position-dividend-growth-portfolio/) and it took me a while to come to that conclusion.

    It seems I take a bit of a different approach but not too different. Every month when I look for a dividend champion to purchase I also see why my larger holdings are not on that list. Recently, it is b/c P/E is a bit too high but the number is never high enough to instigate a sale. I wouldn’t buy something with a 25 P/E but I don’t mind not selling if I still believe in the underlying business…guess that’s not much different than your approach, huh?

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  49. Evan,

    Yeah, just because I might not be interested in buying doesn’t mean I’m willing to sell. The spread between a no on buying and a yes on selling, for me, is quite large. And that’s simply because you then have commissions, taxes, and you also have to put that capital somewhere. In addition, you lose the dividend income from that holding. I’d prefer to just hold and reinvest the dividend income elsewhere if I feel a stock is pricey. That’s just me.

    Best regards!

  50. Hello Jason,
    I think you did great! I dont know if you read a book “Rule #1” by Phil Town but this book suggests to sell your stock when you earn 25% on your stock. Well, I would say 35%. and then buy again or another stock when the price drops.

  51. Happy,

    I’ve heard of that book, but never read it. I may have to take a look.

    Although, I wouldn’t recommend selling after 25% at all. If profits have risen by 25% and the stock price rose in kind by 25% then you’re not really “ahead” and selling is a bad move because, at that point, you’re getting rid of a growing business. I only recommend selling for the reasons I listed above, and I should probably add portfolio management to that. For instance, if you’re allocated too much to one company it may make sense to rebalance, but that’s a slippery slope.

    Best wishes!

  52. I agree that 25% is not enough to sell. But also I noticed that stocks go through cycles. They go up, stay up for a while, then go down and go up again. I am just watching some of my dividend stocks like T, PEP and PM for an example. I had all these three stocks when they were trading at the highest, if I would sell at this moment and buy again when they went down, I could increase my shares of stocks without putting any extra money. I am still not very decisive about selling stocks, but I want to try doing it more and see how it will work.

  53. Happy,

    I hear what you’re saying. I’d only recommend to be careful with that. Effectively, you’re talking about market timing, trying to buy and sell your way around the market. The stock market is littered with battered souls who have tried the same and failed miserably. The long-term trend of high-quality businesses is up, but tying to oscillate around that line can be dangerous. Be careful!

    Cheers.

  54. So how do you feel about owning the non-tobacco cigarette producers stocks? I only own a little through some mutual funds in my 401k, but I have a tendency to choose larger paying dividend producers like SDRL, and I’m considering NLY again at least for a short period of time.

  55. Chris,

    I’m not sure what you mean by “non-tobacco cigarette producers”? I’m assuming you’re referring to e-cigarettes, which I currently invest in via the traditional cigarette manufacturers. Right now, LO is the leading e-cig manufacturer in the U.S. as I pointed out in the post.

    I’d be careful with those stocks. High yield typically equates with high risk. SDRL has been taking on a lot of debt recently, and has negative FCF. And NLY continues to cut its dividend as the share price craters.

    Cheers!

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  57. My main concern with LO has been the explosion of debt on their balance sheet the past 4-5 years. They have essentially added around $2.7 Billion in long-term debt from 2009-2013, and used all of that and more to buy back shares. The result has been their long-term debt to assets ratio moving from around 30% to now over 100%, if my quick glance at Google finance is correct. As with most situations, a high debt level increases the risk and reduces an individual’s or company’s room for error, and their ability to handle severe economic setbacks.

    The debt will have to be repaid with future earnings at some point. I essentially look at this as they are pulling future cash flow to the present, and rewarding current shareholders by juicing the share price via repurchases. Shareholders of the future will not have access to 100% of the business cash flow for dividends/buybacks/company investing in the business as a result of the need to repay this debt (and interest).

    I would love to buy LO, the high profit-margin cigarette manufacturer. Steady-eddie. I am reluctant to buy them when they willingly incur this kind of financial risk. They are too good of an operating company, and the risk of becoming vulnerable is not worth it in my opinion. I don’t need or want them borrowing money (3x annual income!) to invest in the stock market (or pay dividends, for that matter).

    I still have yet to find anybody discussing this… though I haven’t searched terribly hard.

    FYI, the interest rates on their notes vary from 2.3% to 8.125%. Some of the notes are also subject to incremental increases in interest rates if Moody’s or S&P downgrades the LO notes below investment grade. So… disaster hits, and right when things get tough, LO will have to not only manage that, but increase their interest payments if they get downgraded. Got it. (page 51 on 2013 annual report).

    What could possibly go wrong.

  58. John Galt,

    PM has been engaging in very similar moves to LO in regards to debt. I find it reasonable as long as interest rates are on their side, but it’s probably at a level (for both companies) to where it would be prudent to focus on growth instead of taking on more leverage. I think these companies are okay with the debt because of their prodigious free cash flow. It’s not like they have massive assets to maintain.

    And I’m actually okay with mortgaging a little future cash flow for now with the tobacco companies. Those are the only companies that I say that about, and that’s because of the environment in which they operate in with the heavy regulation and taxation. I view my tobacco investments as medium-term – 10 years or so. On the other hand, most of my other investments I’m looking at holding for 20-30 years or more. Because of the uncertainty regarding regulation and tobacco use in the face of secular decline in smokers I’m kind of okay with this strategy. I suppose it’s maximum milking of the cash cow because you don’t know when the milk is going to run out.

    Best wishes!

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