Summary

  • 50% gains possible according to Buffett in arbitrage situations Altria potentially has.
  • Scott Gottlieb has a conflict of interest when it comes to Juul.
  • Altria has a large arbitrage situation currently overlooked by many investors.
  • A Peter Lynch style analysis reveals unrealized value in Altria.
  • Earnings should provide more clarity on how fast this unrealized value is reflected in the stock price.

Warren Buffett made one of those extraordinary claims that require extraordinary proof in a 1999 interview with BusinessWeek. He said investing large sums is a lot harder than investing, say, a million dollars, where he felt he could generate 50% annual returns. Then he corrected himself and said he guaranteed he could do it.

Fast forward to modern times where Buffett has passed at least one rein to younger people to help him invest the massive pile of cash at Berkshire Hathaway (BRK.A). He said he didn’t place any significant restrictions on their investments as long as they didn’t get him in trouble, like buying Microsoft (MSFT) or tobacco companies like Altria (MO). (Buffett is a personal friend of Bill Gates, founder of Microsoft, and could have a conflict of interest if he invested in Microsoft. Buffett worries an investment in a tobacco company would harm his reputation.)

Buffett’s wisdom is legendary. In an interview I once heard him say when asked about tobacco companies: The product costs a penny to make and it’s addictive; What’s not to like?

Indeed! I believe Buffett avoids Altria mostly for reputation reasons. Most readers here, however, are interested in maximizing wealth and are unconcerned with owning oil, automotive, chemical or tobacco companies, as long as they are conducting business in a legal manner.

 

50% Gains

So how would Buffett achieve 50% gains with wealth levels readers here actually possess? 

Buffett said he would look for arbitrage situations to capitalize on. This would mean scouring small companies with hidden value. Of course, this would be a full-time job. But hey, if you can pull a clean half mill a year it might be worth the effort.

If you are allergic to those levels of research there is an easier way if you are willing to earn an above market average, but probably less than 50% annually.

The market is at lofty levels as I write. Most listed companies are trading at nosebleed levels. Unless you are willing to consider the damaged (Boeing (BA) might be on your watch list) or the hated, you are stuck doing the research or accepting market returns, wherever that leads from this market level.

Altria has been a portfolio holding for me for a very long time and it has served me well. Before Buffett asked, What’s not to like? I already knew I liked the company, even if I never use the products. 

Holding Altria for such a long time means I have spent considerable time researching the company. I was there when the world was coming to an end for tobacco in the 1990s due to the massive settlement. 

It seems Altria (and tobacco in general) loves to go into a tizzy every so often. It makes for awesome buying opportunities where the stock price is lower and the dividend yield is higher. Rumors of tobacco’s death are greatly exaggerated. 

Altria is starting to exit one of these “end of the world” scenarios again. The Juul/vaping scare was worse than the damage done in the 1990s when there was a real existential risk.

Of course, there is plenty to worry about. Juul isn’t working as planned. (When does business go as planned?) And cigarette volumes are in a long-term decline. 

Altria does have something Buffett salivates about: pricing power. Altria is likely to increase prices faster than consumption declines. That means more dividends for patient investors.

Juul isn’t dead either! Yes, there are serious problems with getting the Juul transactions approved and Juul is dealing with litigation issues and a declining market share and increased regulations. The Juul approval is more a matter of time and what changes to the deal the government will require rather than a deal that will end up in court or unwound. 

Vaping isn’t dead either! Growth in vaping has slowed. But if you looked at the vaping growth rates a year ago it was obvious growth rates had to slow. Juul was on pace a year ago to be bigger than the entire U.S. tobacco industry in less than 7 years. Reference Stein’s Law: Anything that cannot go on forever, doesn’t.

Health issues surrounding vaping was not due to Juul products. Illegal street vaping pods, usually involving THC, were the chief culprit and maybe the entire culprit.

Juul’s market share has declined from over 80% to ~60%. However, vaping has continued to grow so Juul is getting a smaller piece of a larger market. Like it or not, vaping is the future of nicotine consumption.

 

Scott Gottlieb’s Conflict of Interest

Scott Gottlieb, the former commissioner of the FDA, has managed to get himself a cushy job at Pfizer (PFE). Gottlieb has made it his mission to bad mouth tobacco, but has a special hate for vaping and Juul, the leader in the industry. Now why is that?

Well, vaping has the real possibility of reducing tobacco use and is partly responsible to the increased rate of decline in cigarette use. Gottlieb should be happy with that, but seems to hate the good news. What gives? First, Gottlieb works for Pfizer now, which sells the leading smoking cessation product, Chantix. It becomes clear quickly why Gottlieb is more addicted tobacco than an 84-year-old chain smoker once you realize his income stream is at risk if smoking rates decline too much or too fast.

Second, Chantix is reported to be no better than nicotine patches. Nicotine patches are cheaper than Chantix with fewer side effects. Gottlieb doesn’t seem to want to address this issue during public interviews. 

Third, Pfizer has been busting tail to get a serious warning label removed from boxes of Chantix. Gottlieb took care of that problem promptly once he was working for Pfizer. I’m not saying Gottlieb did anything illegal or unethical. I’m just saying the circumstances does lead one to wonder.

Once you consider Gottlieb’s past with his comments, it becomes clear he likely has an agenda that might not jib with reduced cigarette smoking rates. When regulators and investors realize Gottlieb seems to be encouraging more tobacco use to benefit his employer’s bottom line, his crusade against vaping declines.

 

Hidden Treasure in Altria

I don’t know if Warren Buffett could actually deliver on his promise of 50% annual gains. I do know that arbitrage is an excellent way to spike your investment returns.

A Peter Lynch style review of Altria reveals massive unrealized value. It is easy to forget Altria is more than cigarettes. There is a dash of wine in the portfolio, non-combustible tobacco products, Juul, Anheuser Busch inbev NV (BUD), Cronos (CRON) and on! Nicotine Pouches in the product line as well. 

Let’s take an impossibly negative approach to Altria and see if the company survives or is loaded with large hidden treasures. 

For starters, let’s value Juul at zero. I know, I know. It is worth at least something, but we take no prisoners around here when we tally up a business’s valuation under a worst case scenario. 

Next we gut Cronos’s value and place it at zero, as well. In fact, let’s just value everything outside tobacco at zero, with the exception of BUD.

Altria owns 10.1% of BUD, with a valuation of ~$14 billion as I write. 

Altria has a market cap of ~$95 billion. If everything they own is worth nothing, except for the investment in BUD, which has no restriction on the holding starting in 2021, Altria has a core valuation of ~$81 billion. 

This valuation is for a company kicking out over $7 billion in cash flow without help from Juul! 

And let’s be honest, all that other stuff Altria owns has some value. How much is still to be determined. That is how it works with businesses. Value has to be created to be realized. (Remember the formula for value creation: Return on Invested Capital (ROIC) minus Cost of Capital (COC). A positive number is value creation.)

What we do know is Altria’s core business is kicking out loads of cash to pay down debt (on the 3rd quarter earnings call Chairman Howard A. Willard stated Altria paid down $1 billion of debt in the 3rd quarter and planned on paying down a similar amount in the 4th quarter of 2019), buy back stock, pay dividends and grow the business. 

 

Earnings Report

Altria’s upcoming 4th quarter 2019 earnings report will clarify some of these issues. I am interested to see how much debt was actually reduced. I also want to see how cigarette volumes are holding up and if we will have two or three price increases in 2020. 

Juul is the unknown. Will more write-down be in the cards? My gut tells me things are stabilizing at Juul, but gut is not an acceptable investment tool and has a poor track record. Cronos still has a lot of work to do to reach profitability.

A bright spot is the non-combustible tobacco products. Chew has been growing, but is still a relatively small part of the business.

What interests me more than any other product is iQOS — the heat, not burn product — licensed from Philip Morris International (PM). FDA conditional approval is a significant advantage Altria received in 2019. iQOS is rolling out in a measured fashion as you read.

The future of tobacco is in the non-combustible, reduced-risk products. Wouldn’t it be a kick if Altria found serious value in iQOS instead of Juul?

Either way, I think there is massive hidden value in Altria. With such a diverse mix of products, Altria is well situated to keep pumping out large, growing dividends for a long time to come. 

Unless you have a convincing argument people will quite smoking tobacco and using weed, chewing, vaping and drinking beer and wine, I think Altria has a bright future.

 

* Notes: As longtime readers of this blog know, I own shares in Altria and use it as an investing test model. Originally written for Seeking Alpha, this post provides an update on my reading of the tea leaves. I still own and plan on continuing to own shares in MO and PM. I own a small amount of BA and MSFT as part of my watch list. I do not own shares of other companies mentioned in this post at this time with no plans to open a position either.

 

More Wealth Building Resources

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

In 1968 Nick Murray had to sell investments the hard way. He met most clients in their home. The tool of choice was the mutual fund. Most people he sat with were hard working people, but unsophisticated  investors. Fee-based advisors were rare in those days for the small accounts families had. Fees were high and people were risk adverse. To top it off, the market was having bouts of volatility, suffering a noticeable decline even to those who didn’t follow the market on a regular basis.

It was in this environment Nick Murray had to convince his clients and potential clients the best course of action for them. Investing in mutual funds came at a steep cost. Loads (aka sales fees) were as high as 8.75%. 91.25% of your money went to work right out of the gate trying to get back to the even water mark.

Nick Murray

Young families had to consider equities for at least a portion of their portfolio if they were ever to have enough money for a comfortable retirement, and Nick Murray knew it. The high fees were one issue; the market another. The question was always the same:

“Do you think the market will go up?”

An honest financial planner will never tell you the market will go up because no one has a crystal ball. Markets do go down at times, and significantly. In the long run stocks would provide the best return on investment if placed in a broad-based mutual fund. The gut-wrenching declines that show up now and again was the problem. Nick Murray had to provide comfort for the clients he served while encouraging the best financial behavior. He said:

“I do not know if the next move in the market will be up or down. The next 20% move could go either way and I have no way of knowing which way it will be. The same is true for the next 50% move. I just don’t know if the next such move is up or down. The same with the next 70%, 80% and even 90% move in the market. But I can guarantee you the next 100% move in the market is up, not down.”

How could Nick Murray make such a claim? Of course, the next non-100% move in the market is anyone’s guess. But to guarantee the next 100% move was up! 

Nick Murray spoke at a H.D. Vest Financial Services conference in Dallas in December of 1994 when he told this story. (I might be off a bit on the date as I’m pulling from memory only. It was December because H.D. Vest always had their December conference in Dallas. The year was 1992 to 1994, with my bet placed on 1994.) Murray explained why he made the statement to clients he did. He said:

“I could guarantee the next 100% move was up because the next 100% move has always up. And if I were ever to be wrong there would be nobody left to discuss it.”

Those words always stuck with me. Every bump in the night, ah, the market is not a cause for panic. Even if I bought at the height of the market in 1987 or 2008, it didn’t take long before another 100% gain was notched onto the market. Even the 1929 high eventually fell to substantial 100% gain after 100% gain.

Once again we face a market with a long up trend and worries abound. 

And now is a good time to ask if you need a financial planner.

 

What a Good Financial Planner Does

Financial planners come in so many flavors. Some are honest and good at what they do. Some are out for a quick buck. Others are incompetent, at best.

Earlier this week I met with a client in my office. This elderly couple had worked beyond the normal retirement age, but now were putting traditional labor in the past. They are simple people that prefer as little complication as possible. 

My husband/wife client have never used a computer. Normally I suggest a good index fund at Vanguard or Fidelity. That wasn’t the right advice in this instance. The 401(k) administrator (Transamerica) presented all the options. 98% of the page was annuity choices: single life, period certain, joint life. Way at the bottom was the lump-sum option.

My client was clear they did not need any of the money. They were aware of the required minimum distribution and that is all they would take from the funds.

So what does an honest financial planner tell a client in a situation like this? They didn’t need the money. They were not sophisticated investors. They were risk adverse. They had more than enough for anything they wanted.

After a half hour of discussion it was clear to me my client did not need an index fund or any other fancy sort of investment. I asked where they banked. It was a good local bank. I explained to them what laddered CDs were. They understood CDs and what I suggested. By the time you read this they will be working with their banker carrying  out what I feel is in their best interest. The interest earned will be small, but it is what serves this client best.

 

A good financial planner will be honest with her clients. No one size fits all. Usually when working with young families I have to spend serious time getting them to invest in equities. (Too often I must work my fingers to the bone convincing them to pay down debt and invest even a token amount.) 

I’m not a big fan of life insurance. (Don’t get me started on annuities.) However, there have been instances where the facts and circumstances indicated a client should have term life insurance. Business clients might best be served with key-man insurance or a policy for a buy-sell agreement. There have even been a few cases where the facts required I suggest annuities. With annuities I always go into a long-winded explanation of the high commissions so clients understand how much it pains me to make such a recommendation because I know commissions are ultimately paid by the client.

 

The most important task a financial planner has, in my opinion, is to prevent clients from panicking in a downturn and contain greed when the market is soaring.  Nothing else a financial planner does will do more to increase the value of a client’s account. 

As an accountant I see many clients. Over the years way too many have committed financial suicide because they got scared out of the market at a bottom. I’ve also seen too many invest on margin (borrowed money) when the market is hot. If I could have one wish, it would be to go back in time and convince more clients to walk away from a hot stock tip. A good financial advisor should encourage good long-term investments, like index funds. Sophisticated investors can invest in individual stocks because they know how to value a business. They use different financial planners from the proletariat. 

 

The duty of a good financial planner is simple: Stay in touch with clients to understand their financial plans and needs, helping them achieve those goals. In other words: Know Your Client!

It is easier than ever to walk the financial road without a financial planner. Mutual fund fees have collapsed to zero in some cases. (Does anyone pay a load anymore to buy a mutual fund?) ETFs are very low cost to buy. Automatic investing is easier than ever. 

The real questions is: Do you need a financial planner? There are only a few questions you need to ask yourself to get the answer:

  • Do you understand the investment choices available and the risks and consequences? Honestly!
  • Do you understand the tax implications? Or have a trusted tax professional to help you understand the tax issues?
  • Do you tend to want to “trade” the market?
  • Have you ever sold or panicked when the market was down? Be honest! How did you react, or not react, to the 2008 economic, housing and market meltdown?

 

Financial planners are different from the past. Many brokerage houses (E*Trade, Vanguard and Fidelity, for example) have in-house advisors available to help you make financial decisions.

Some advisors still pay house calls, but they are getting rare. And since commissions are totally different from a few decades ago when I was in securities, an alternative to a financial planner might be a better choice.

 

 

Alternative Financial Planners

While many consider stock brokers and insurance people financial planners, the truth is they are really salespeople for the firms they are appointed with. These traditional advisors still play a role in financial planning. However, their role is diminished compared to even recent times.

The stock broker wants to sell you stuff that generates a commission or fee-based product. So does the insurance guy. It’s how they keep the light on and I have no problem with that. Many financial planners are fee-based only today, charging 1% or something similar per year on the assets they manage for you. The fee seems small, but accumulates to a large amount over the years. And remember, the fees paid also no longer generate future returns for you.

 

There are two natural professions that can help you with your financial planning needs: attorneys and accountants. The accountant should not also sell products or fee-based services as well or you will find recommendations slanted toward what they sell.

Helping a client by telling them the truth — that they should use laddered CDs — is something an accountant can tell you. I don’t get paid a commission. I charge for my time and have no vested interest in the investment the client makes. 

As an accountant I can also help facilitate the process. If a client needs a Vanguard account I can walk through the set-up process with them or they can call Vanguard. All the client pays for is my time. 

Attorneys can play the same role. They might be more expense and have less time to work with you, but attorneys play a vital role in personal finances. Wills and estate issues will require an attorney anyway. The attorney and accountant can work together to help you deal with issues such a Medicare and future potential nursing home expenses. 

A good attorney and accountant can also keep you honest when the market is soaring or in free fall. These professionals have seen it all before in the market and in their client’s accounts and they don’t shake easy. Clients in my office know I wear cast iron underwear when it comes to taxes, investing and personal finance issues. I’m not moved by headlines! And I doubt your attorney is either.

 

Have an honest discussion with your accountant or tax professional. They might be the perfect choice for a financial planner. 

This makes even more sense if you handle your own finances. Having a disinterest third-party to bounce ideas off of in very valuable. When I’m not writing or preparing taxes, I am working with clients and readers of this blog, consulting on a variety of issues, including: index fund/equity investments, insurance, retirement planning, Social Security and Medicare planning, tax planning, business formation and session planning, and more. It amazes me the topics I discuss with clients. I get to enjoy some unique research at times which keeps me young.

 

Many people reading this blog are informed enough to actually be a financial planner themselves so you probably think you can handle it all on your own. I understand. The history of financial planners and advisors is not encouraging.

Consider an alternative to the traditional financial planner. At least in my office, I help clients make the right choice for them and send them to the most appropriate professionals to carry out the directives.  

Most important, always keep learning because everyone actually does need a financial planner. And the best one you can ever have is you. Because no matter how hard I try to know my client, you know you better than I ever will. My performance is best when my client also understands the rules.

 

This is an important topic. I hope we get a lively debate in the comments on how you, kind readers, interact with financial planners. My ideas are good, but as a team our knowledge will be more than the sum of the parts.

 

 

More Wealth Building Resources

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Worthy Financial offers a flat 5% on their investment. You can read my review here.