Walk a Mile for These Cigarette Makers

 | May 16, 2013 | 5:00 PM EDT
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Some products, legal as they are, have a public image that makes investors cringe. One such product is tobacco. Its deleterious health effects are well known, but that does not mean the companies that produce cigarettes will make your investment portfolio sick.

True, cigarette use has fallen globally. According to a Stanford researcher, global tobacco use would be declining were it not for China, which has 350 million smokers and produces 40% of the world's cigarettes. Lest you think no one smokes in the U.S., just look outside virtually any office building where, no matter what the weather, you will find people lighting up. The Wall Street Journal recently reported that teen smoking in New York City hit a low of 8.5% in 2007 -- a rate that has not fallen since. That's a big drop from 15 years ago when a quarter of New York high-school students smoked, but there are still plenty of smokers among the younger set in this country -- and plenty more abroad.

I am not recommending smoking to anyone, but if you do have no moral qualms about investing in tobacco, two giants of the industry look like good opportunities. Lorillard (LO), the maker of Newport and Kent cigarettes, is worth a look. It just reported first-quarter adjusted earnings per share that were up 13.8% and revenues up 3.3% compared with a year ago. Plenty of companies in today's economy would be happy with those numbers.

My Joel Greenblatt-based strategy (I automate the strategies of noted Wall Street investors and use them to choose stocks) recommends this stock. The strategy looks at two variables and ranks them among all the listed publicly traded U.S. stocks. Earnings yield provides a ranking of 154 for Lorillard and return on total capital has a ranking of 32. The strategy then takes these rankings and comes up with a final combined ranking. Among the thousands of stocks in our database, this company is ranked an impressive No. 20.

Philip Morris International (PM) produces seven of the top 15 international cigarette brands, including best-selling Marlboro. The company's products are sold in more than 180 markets around the world. This is a company with a very solid leading position in its industry. It has 16.3% of the total international cigarette market outside of the U.S. and 28.8% excluding China. Note that the U.S. market for its brands is now in a separate company, Altria Group (MO).

My James P. O'Shaughnessy strategy recommends Philip Morris. It likes the large market cap ($157 billion), strong cash flow per share, large number of shares outstanding and huge sales ($78 billion). Companies that pass these tests are subject to one additional hurdle to earn a recommendation: They have to be among the top 50 based on dividend yield. With a 3.5% yield, Philip Morris is one of these elite stocks.

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