MO Money, MO Problems

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Now, who's hot, who's not? Easy: the industry that sells flammable products and is widely regarded as the least moral stream of profitability, big tobacco.

If you're squeamish about investing in "sin stocks," that's fine. But before you leave, take one look at the following chart. A glimpse of the past three years reveals that tobacco stocks have handily outpaced the Dow Jones Industrial Average (INDEX: ^DJI) .

But you'd be silly to think that all this profitability doesn't come without some difficulty.

MO money, MO problems
The dividend kingpin of this group, Altria (NYS: MO) , continues to catch heat. The company recently announced it will record a $119 million fourth-quarter charge related to two lawsuits. While the cases rack up a $62 million pre-tax charge, the related interest expense of $57 million almost doubles Altria's actual expense.

Altria's fat cash balance of more than $3 billion means it probably won't sweat over these charges. Considering the $1.17 billion profit it recorded in its third quarter, it has the pockets and cash flow to pay off charges like this well into the future. But as many of these barons realize, it's like the more money they come across, the more problems they see. So with money in the bank, and targets on their backs, industry cohorts such as Lorillard (NYS: LO) , Reynolds American (NYS: RAI) , and Vector Group (NYS: VGR) can expect the lawsuits to keep rolling in.

While this ruling isn't exactly a performance anchor for Altria, it's indicative of the larger environment it faces. Big tobacco is between the unenviable rock, hard place, and harder place of litigation, taxes, and regulation. While it won an irregular victory at the hand of U.S. District Judge Richard Leon, that's hardly the sort of performance it can bank on. It continues to face pressure in Australia, where its packaging remains under fire.

On the lam
Sometimes a company just has to get out of Dodge to capture big profits. It's this reality that prompted the 2008 spin-off of Philip Morris International (NYS: PM) from Altria. By focusing internationally with the Marlboro brand, while Altria focused domestically, Philip Morris was more insulated from U.S. litigation, regulation, and taxes. International markets are generally less hostile toward tobacco in these areas.

Best frenemies
Sometimes, though, the government and big tobacco are frenemies of sorts. That's because tobacco's practiced profit-making places it squarely in the sights of legislators looking to fill budget shortfalls or raise revenue.

And, oh, what revenue it brings in. In 2009, tobacco taxes racked up an impressive $17 billion for the U.S. government. While federal governments like to hike tobacco taxes -- 46 states and the District of Columbia have raised them more than 100 times since 2000 -- they need to be cautious. For instance, revenues have not gone up as quickly as taxes have been increased, suggesting that higher taxes put downward pressure on sales. This could also be exacerbated by a slowly declining smoking population in the U.S., meaning the cash cow of tobacco sales could wither up if government gets too greedy and raises taxes too much. It's for this same reason that I feel cash-strapped states are less likely to push through more smoking bans and restrictions at this time.

99 problems but a pick ain't one
Given the nature of tobacco companies, I've set my sights abroad. Philip Morris is arguably the best-positioned of the companies mentioned here. It consistently pays dividends topping 4%, has a conservative (for tobacco companies) payout ratio of 55%, and with a three-year dividend growth rate of 39.1%, it likes to give it back. Philip Morris' international presence removes it from many of the hostilities found in the U.S. market. With third-quarter revenue up 26% over last year, the company is demonstrating its international chops well.

There are other domestic options for those who like to play in domestic soil. If you want to get out of the game, flip, and go legit, there is always Star Scientific (NAS: CIGX) . The smokeless tobacco company has seen weak performance lately but is a technological pioneer in its field. With smokeless tobacco products increasing sales as cigarette sales shrink, it could have a big upside. Granted, you don't get the fat dividend you get with traditional cigarette companies, but you also avoid the most destructive legislation and lawsuits, which traditionally miss smokeless products.

Earning an honest living
If you like the idea of these monster dividend yields but are uncertain about all the negative forces surrounding big tobacco, I invite you to check out The Motley Fool's special free report "Secure Your Future With 11 Rock-Solid Dividend Stocks." Thousands of investors looking to land consistent income have already requested it. It's free!

At the time this article was published Austin Smith owns no shares of the companies mentioned here. The Motley Fool owns shares of Altria Group and Philip Morris International.Motley Fool newsletter serviceshave recommended buying shares of Philip Morris International.Motley Fool newsletter serviceshave recommended creating a bear put ladder position in Lorillard. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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