Better Buy: Altria Group Inc vs. Verizon Communications Inc.

By Brian Stoffel Markets Fool.com

Image credit: Getty Images

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Let's not beat around the bush: on the surface, this seems like a very odd pairing. Usually, in these "Better Buy" articles, we pit two companies against each other that are in the same field. But here, we have a giant telecom in Verizon (NYSE: VZ) going up against the country's leading cigarette-maker in Altria (NYSE: MO)

While some might consider this a silly exercise, I actually think it's quite valuable. Investors search all over for the best investments, and need not be confined to one industry. Furthermore, these are two stalwart dividend payers that many consider adding to their retirement portfolios. As such, I think there's a lot that can be gained from comparing the two.

But which is the better buy today? It's tough answering that question with two similar companies, even harder in this case. Nonetheless, there are three lenses through which we can view the question to get a better idea of the variables at play.

Financial Fortitude

Obviously, shareholders of these two companies love seeing cash returned to their pockets -- either in the form of dividends or share buybacks. But we can't underestimate the power of cash in the bank.

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Every company, at one point or another, is going to face hard times. When a company has a robust war chest, such times can actually be beneficial. These companies can outspend rivals, buy back shares, or even make strategic acquisitions.

Their debt-laden brethren aren't nearly as lucky -- forced to myopically focus on making ends meet in an effort to stave off bankruptcy.

Here's how Altria and Verizon stack up in terms of financial fortitude; keep in mind that Verizon is valued at roughly 65% more than Altria.

Company

Cash

Debt

Net Income

Free Cash Flow

Altria

$2.3 billion

$13.9 billion

$5.2 billion

$5.0 billion

Verizon

$7.6 billion

$103 billion

$14 billion

$11.5 billion

Data source: Yahoo! Finance, SEC filings

There are two things I want to point out here. The first is that Verizon has a very unfavorable cash-to-debt ratio. While this is common in the telecom industry -- where huge upfront costs have to be paid to build out a network -- it's extreme here. This is largely because Verizon bought out the stake that Vodafone (NASDAQ: VOD) had in Verizon Wireless. That was definitely a good move, but also an expensive one.

As such, with both companies bringing in more than enough free cash flow to meet their debt obligations, I'm giving the nod to the less-leveraged company.

Winner = Altria

Sustainable competitive advantages

Of all the variables one can try to capture, this is probably the most important -- and hardest to measure. A company's sustainable competitive advantage -- referred to commonly as a "moat" -- represents the special "something" that sets it apart from the competition and makes it unique.

In the world of cigarettes, brand and scale mean everything. Because Altria is the largest cigarette maker in America -- with a market share of 51.4%-- it has massive scale that can help the company get lower prices on commodities, and pass those savings along to customers.

More importantly, however, the company owns the Marlboro brand. Affinity toward a brand is probably the strongest when it comes to these addictive substances. It helps explain how the company has been able to continually generate positive returns for investors even in the face of lowered rates of smoking.

Verizon, on the other hand, benefits from both high barriers to entry and a market-leading share of wireless customers. There are, essentially, four major wireless carriers in the U.S., and Verizon is the largest -- though only slightly over AT&T (NYSE: T) -- with a 35%share of the market.

It is very difficult for others to enter the field, as the costs for building out such a network are massive. It will be interesting to see how Verizon's foray into ancillary fields -- through the acquisition of Yahoo'sproperties, AOL, and others like them -- plays out. For the time being, however, it's too early to see what type of moat this provides.

In the end, I have to give the nod to Altria. The strength of the Marlboro brand has been questioned and tested for decades; while wireless customers will often switch to the lowest-cost provider, the same simply doesn't hold true for cigarette producers.

Winner = Altria

Valuation

Finally, we have valuation. While this isn't an exact science, there are some straightforward metrics we can consult to give us an idea of how expensive each stock is.

Company

P/E

P/FCF

PEG Ratio

Dividend

FCF Payout Ratio

Altria

22

26

2.7

3.6%

85%

Verizon

14

19

3.0

4.3%

79%

Data source: Yahoo! Finance, E*Trade. P/E represents figures from non-GAAP earnings.

On this basis, I find it much easier to side with Verizon. Many are expecting consolidation within the cigarette industry, which could be a significant boon to Altria's long-term prospects. But the stock is trading for particularly high multiples.

With a hefty dividend and a slightly healthier payout ratio from free cash flow, I think Verizon is the cheaper stock to buy today.

Winner = Verizon

Final Call: Altria

So there you have it. Altria may be the more expensive stock, but by buying shares, you get less leverage and more of a sustainable moat for your money. Verizon may well end up being the best stock to buy, but given the information that we have at this point -- and the strength of Altria's brand power through Marlboro -- I think dividend investors would do well to consider buying shares of Altria moving forward

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Brian Stoffel has no position in any stocks mentioned. The Motley Fool recommends Verizon Communications and Yahoo. The Motley Fool has a disclosure policy.