The Investment U e-Letter: Issue #605
Friday, November 10, 2006 Tobacco Stocks: “Smoking” Out Investment Profits From A Blue Chip Titanby Floyd G. Brown, Guest Contributor, Investment U
Editor's Note: Today I’ve asked my old friend Floyd Brown to write a guest column on his technique of profiting from lawsuits and government investigations against big business. Floyd is the former Director of the Reagan Ranch in Santa Barbara, California, a fundraiser extraordinaire, and one of the smartest private investors I know. ~ Mark Anyone who’s suffered from an unfair lawsuit or government investigation knows how devastating it can be to your business, your finances and your personal life. But for investors in big business, it can be a boon… Look at the lawsuits against: - Big pharmaceuticals – Merck (NYSE: MRK)
- Big oil – Texaco, a brand of Chevron (NYSE: CVX)
- Big insurance – AIG (NYSE: AIG)
In practically every case, if you held on, or bought after the announcement of an investigation or lawsuit, the stock recovered from its losses and, in some cases, moved substantially higher. When corporate America is harassed by the powers of Washington (or New York, in the case of Eliot Spitzer), fat profits can be just around the corner for contrarian investors. Tobacco stocks are the perfect example… Profiting from Big Tobacco In September 1999, Attorney General Janet Reno launched a massive lawsuit against America’s tobacco companies. “Smoking is the nation's largest preventable cause of death and disease,” she said. “And American taxpayers should not have to bear the responsibility for the staggering costs. For more than 45 years, the cigarette companies conducted their business without regard to the truth, the law, or the health of the American people.” The suit named the following corporations and entities: - Philip Morris (now Altria Group (NYSE: MO)
- R.J. Reynolds Tobacco (NYSE: RAI)
- Brown & Williamson Tobacco (now owned by R.J. Reynolds)
- Liggett & Myers (NYSE: VGR)
- The Council for Tobacco Research U.S.A. and
- The Tobacco Institute.
And its intended purpose was to recover billions of dollars taxpayers have spent on smoking-related health care, accusing cigarette-makers of a “coordinated campaign of fraud and deceit.” The lawsuit was filed in U.S. District Court and alleged the tobacco companies conspired since the 1950s to defraud and mislead the American public and to conceal information about the effects of smoking. Not much basis in law for these attacks… Robert Levy, a senior fellow at the Cato Institute, wrote at the time: “Never mind that Attorney General Janet Reno and her minions in the Justice Department have said repeatedly that the federal government has no statutory authority to bring a direct suit to recover smoking-related damages. When the objective is to replenish depleted Medicare coffers, anything goes – including the rule of law.” At 45, I have known my entire life that tobacco products kill. I still remember passing the smoker’s lung around and comparing it to the non-smoking lung in health class. It is hard for me to believe that there was a time when the health benefits of smoking were actually promoted. But I imagine few smokers are around today from that bygone era. Investing in Tobacco Stocks... and How It Pays to Bet Against the Government As an investor, I have learned an important lesson watching these attacks: Government investigations and lawsuits can either be devastating to investors – or hugely profitable. In the case of Big Tobacco, my strategy was to invest in tobacco stocks right after the lawsuit was announced. Tobacco giant Philip Morris shares were changing hands for as low as $33.81 per share at the time. With headlines trumpeting the suit in business magazines and newspapers, weak investors fled the historically stalwart tobacco stock, taking shares of one of America’s great profit machines down to under $20 per share. Shortsighted investors who sold out of the stock saw their profits go up in “smoke,” but those who bought during the panic profited in the long run. I didn’t buy the stock at its low (I acquired my shares at $27.81), but they’re up 191% so far… not including dividends. Any of these tobacco companies attacked by Janet Reno in 1999 have followed similar trajectories. Loews Corp. (NYSE: LTR), for example, is up 167%, and US Tobacco stock is up 166%. These gains also are not including dividends. Every time Altria Group (formerly Philip Morris) lost a case in court, or the government initiated another attack, the stock has fallen, only to return to new highs. The strategy: Buy when there’s fire. See the chart below. 
Investors Get Fat Dividends from Tobacco Stocks, Too Part of the allure of these stocks is the cash they generate for shareholders in the form of dividends. You can use these dividends to buy more shares or buy other undervalued and unloved companies. And the kicker is that when you hold these stocks for long periods of time, you avoid capital gains taxes and the transaction costs that come with trading. You can rarely find these kinds of long-term gains in risky technology and small-cap shares. And remember, tobacco stocks are not the only ones to soar after facing unprecedented attacks by government agencies. Giant pharmaceutical companies, like Merck and Pfizer (NYSE: PFE), oil companies, like Exxon Mobil (NYSE: XOM) and Chevron, and insurance companies, like AIG, have been slaughtered by government regulators’ accusations and lawsuits. Each of these companies has roared back to give patient and contrarian investors outstanding returns. Don’t panic when the government goes after a giant corporation. Hold your nose and buy! Good trading, Floyd Today's Crib Sheet:- Despite news of a potential tax liability of $5.58 billion this week, sending shares of Merck (NYSE: MRK) down nearly 7%, the stock has recovered strongly from its litigation woes – up more than 62% since last October.
- High-quality dividend-paying stocks are vital components to your portfolio… especially if you’re in or approaching retirement. That’s why The Oxford Club has built a virtual ATM for investors: The Perpetual Money Portfolio, which generates 96 dividend checks a year. As of yesterday, members were sitting on gains in all eight quality dividend payers. If you’d like to learn more about the Club, here’s how to become a private member.
Shock Stocks: - Genentech, Inc. (NYSE: DNA) announced Thursday it will acquire one of its smaller competitors, Tanox, Inc. (Nasdaq: TNOX), a biotech specializing in the discovery and development of biotherapeutics. The deal, worth $919 million, sent shares of Tanox 43% higher.
- Here’s another blockbuster deal in our Takeover Trader service, which could trigger a substantial pop in the shares by November 30.
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