2 Reasons Why Philip Morris Belongs In a Well-Diversified Portfolio

Source: Thinkstock

Source: Thinkstock

Philip Morris (NYSE:PM) has missed out on the outsized gains that we have seen in the tobacco space this year, and there are a couple reasons for this—both of which stem from the fact that the company operates exclusively overseas. The first is that the consolidation between Reynolds American (NYSE:RAI) and Lorillard (NYSE:LO) make the competitive landscape in the United States easier to navigate. With fewer players competing for the same market each player will have more pricing power and fewer marketing strategies to worry about.

The second reason is that the company earns its profits in foreign currencies—especially in emerging markets—and many of these currencies have been weak against the dollar year over year. This makes the company’s earnings look worse by comparison.

As a result the stock is actually down about 3 percent for the year even though the rest of the sector has easily beaten the S&P 500.

Now an initial glance at the company’s Q2 earnings show why the stock is underperforming—net income fell 13 percent. But if we correct for currency fluctuations and one-time items the company actually reported a 9.5 percent increase in income. If we adjust earnings per share we see a 20 percent gain—thanks to an aggressive stock repurchase program. If we adjust revenues for currency fluctuations we see a gain of 1.5 percent. In short we see a company with modest growth and successful cost cutting measures.

Generally I think this is a bad way to look at things. After all we can make all sorts of adjustments to any company’s earnings in order to bias the bullish or bearish case. But I think we need to take a look at the disparity between the company’s actual vs. adjusted numbers in the context of the stock’s performance, and what you want to achieve in owning shares of Philip Morris.