Friday, January 20, 2012

Research: VGR Vector Group, Misleading Dividends

I'd have to say be careful with this one. VGR pays an attractive and consistent dividend. Consistency should not be maintained at the cost of internal rotting. Just as GM had begun taking out loans in order to keep their dividend payouts consistent with history, you need to look a little further to see the deterioration of a business. VGR has doubled their revenue from 506M in 2006 to 1B in 2010. However, gross profit has remained consistent at around ~200M. This means that their profit margin has been decreasing.

VGR Financials from MSN

For simple business such as VGR which purchases inventory and sells the product, we'd like to see the gross profit rise at least proportionally to revenue. Successful software companies can build one product and sell it infinite times, causing a proportionally larger jump in margin as revenue increases.

The problem with a decreasing profit margin is it becomes harder to maintain the same level of dividends as you make less money. As a result, you see VGR issuing more debt and then paying the proceeds as dividends. You see a rise in interest expense year after year as their debt continues to grow. To top it off, the PE ratio is currently at 17, and I don't believe there is enough growth potential to justify it.

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