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Why Philip Morris’s Valuation Multiple Fell: Weak 1Q17 Earnings

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Valuation multiple

Valuation multiples help investors make investment decisions. They’re driven by investors’ willingness to pay, perceived growth, risks, and uncertainties. Of the various available valuation multiples, we’re using forward PE (price-to-earnings) multiples, given the high visibility of Philip Morris’s 1Q17 earnings. The forward PE ratio is calculated by dividing the company’s stock price by its forecasted EPS (earnings per share) for the next 12 months.

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PM’s PE multiple

The lower-than-expected 1Q17 earnings appear to have made investors skeptical of Philip Morris’s future earnings, leading to a fall in its stock price and forward PE multiple. As of April 24, 2017, Philip Morris was trading at a PE multiple of 22.3x compared to 22.5x before the announcement of the 1Q17 earnings on April 20, 2017.

Comparatively, on April 24, 2017, Philip Morris’s peers Altria Group (MO) and Reynolds American (RAI) were trading at PE multiple of 21.5x, and 24.4x, respectively.

Growth prospects

To meet the growing need for HeatSticks, Philip Morris has been investing $1.6 billion in 2017 to increase its HeatSticks manufacturing capacity from the current 15 billion units to 50 billion units. Also, the company is planning to expand the introduction of iQOS to 30 to 35 markets by the end of 2017 from the current 24 markets. These initiatives are expected to increase PM’s expenditure.

If iQOS fails to generate expected sales, the increased expenses could pressure Philip Morris’s margins, lowering its earnings. For the next four quarters, analysts are expecting Philip Morris to post EPS growth of 12.3%, which could have been factored into its current stock price. If the company posts lower-than-expected earnings, the selling pressure could bring its PE multiple down.

You can mitigate these company-specific risks by investing in ETFs such as the iShares Select Dividend ETF (DVY), which has invested 3.4% of its holdings in cigarette and tobacco companies.

In the next and final part of this series, we’ll look at analysts’ recommendations and target price for the next 12 months.

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