Philip Morris Bear's Den
by Paul Larson [email protected]

When one thinks about investing in Philip Morris, one cannot avoid considering the ethical issue over profiting from the death of others. It may sound like a bold statement to make, but it's the truth. Nevertheless, we are not here to argue the merits of socially responsible investing. We dealt with that issue in Dueling Fools not too long ago. What we are arguing here is the investment worthiness of Philip Morris as a stock.

While I may not shame Dale for his shaky ethical standards here, what I will say is that Philip Morris very much deserves the discount it trades at. It deserves the discount because there are a large number of people like myself who would never directly own a cigarette company for ethical reasons. Furthermore, the company's main profit generator, tobacco, is a lightning rod for political punishment and legal retribution.

Let me say again that I am not here to make a value judgment on what investors should or should not buy. The issue of ethics is a sticky one, and everyone needs to decide for themselves what is and is not acceptable. Personally, I would never own a stock that profited so directly from tobacco. It's my own ethical decision, but it's not a decision I am alone in making.

If we use the voting results from the socially responsible Duel as well as from a previous Polling All Fools feature, we can get a rough proxy for those who think socially responsible investing has merits. Some 42% of those voting in the ethical investing Duel voted that the "for" case was more compelling than the "against" case. Of even more relevance, a whopping 46% of those responding to Polling All Fools said, "No. I don't want to invest in a company associated with tobacco." Whatever way you want to cut it, it is clear that there is a large chunk of the investing public that would never buy Philip Morris due to ethical considerations alone.

"So what?" I can hear Dale saying already. The "what" is that the potential pool of investors looking to buy Philip Morris is greatly diminished. The stock market is like any other market with buyers, sellers, and an equilibrium price. When a large part of the buying equation is taken away, it only makes sense that the price and therefore the market multiples the stock trades at are going to be inherently discounted. Let me put it to you this way: Don't expect me or a great number of other investors to ever buy your Phillip Morris stock should you try to sell it down the road.

Let's now move to the legal and political risk the company faces and why those risks will always be priced into the stock. Since the vast majority of Philip Morris' profits come from the sales of cigarettes, namely the Marlboro brand, there is a colossal political and legal risk the company faces down the road. And because smoking is a habit that is becoming increasingly unpopular in our society, the political forces are mounting to tax and regulate the product even further than it already is.

Simply said, increasing tobacco taxes is the political equivalent to targeting the side of the barn. Call me nuts, but I certainly don't want to put my cash into Philip Morris' barn.

Of course, I would be remiss if I did not also mention the mounting legal liabilities the tobacco companies potentially face in the future. I could easily spend hours doing nothing but typing a list of all the personal injury and product liability cases pending against the company. Everyone from smokers, healthcare companies, state and federal governments, workers exposed to second hand smoke, and families of deceased smokers are lining up to take their shot at getting a piece of the Philip Morris pie. It is this Fool's opinion that many of the claims probably have a great deal of merit. Any "government settlement" would probably be just the tip of the proverbial legal iceberg concerning punitive damages.

Restated, the company's debt to society is onerous, but it won't show up on the "liabilities" side of any balance sheet. The market is clearly discounting this "debt" by giving decreased trading multiples to the company, but even the market may be underestimating the potential monetary damages Philip Morris could pay down the line.

Notice that I have not mentioned valuation once in this Duel thus far. I don't need to. I'll be frank and point out that the company's earnings, margins, and dividend are all quite impressive relative to many of the other Dow Industrial stocks. Nevertheless, there's a good reason for the discount, and that reason is spelled R-I-S-K. We're talking both political risk and legal risk. I really don't care how cheap the stock is; I -- and many others like me -- would never own the company. A stock's value is what someone is willing to pay for it, and a large swath of the investing community is saying they would never buy it. You can draw your own conclusions, but I know what I think Philip Morris is worth.

Next: The Bull Responds