The impressive long-term yield of Philip Morris International (PMI) underscores a critical principle in the investment realm: what truly matters is not the actual profit growth rate, but rather the comparison of that growth with market expectations. A combination of lower expectations, higher growth rates, and substantial dividend payouts sets the stage for robust yield development. This multifaceted dynamic reveals why PMI has emerged as one of the top picks for long-term investors.

In his investment classic, "The Intelligent Investor," Benjamin Graham argues for the undeniable merit of stocks as the superior investment class over the long term. Philip Morris stands as a compelling exemplar of this claim, boasting a compound annual return of about 17% from 1925 to the end of 2003— outpacing the broader market index by 7.3 percentage points. Such remarkable figures quickly draw attention to an investment that continues to inspire debates among analysts and investors alike.

A recurring theme in various investment texts is the historical context of corporate returns, which suggests that the highest returns in U.S. history weren’t attributed to tech giants or energy corporations but rather to an oft-overlooked consumer goods company: Philip Morris. Over the past 60 years, the company's stock price has skyrocketed over 60,000 times, establishing it as one of the best-performing stocks in the American market. However, while discussions around the firm’s long-term returns abound, analyses surrounding operational changes are less prevalent. A closer examination of Philip Morris’s most recent quarterly report provides insights into why this company has remained a favored long-term investment target.

Undoubtedly, a transformation is underway at Philip Morris, marking a significant shift from traditional tobacco to smoke-free alternatives. Tobacco has long been the company's flagship product, with its most notable brands including Marlboro cigarettes, the IQOS heated tobacco system, and ZYN nicotine pouches. Marlboro effortlessly stands alongside Coca-Cola and McDonald's as one of America’s most recognized brands. However, awareness of tobacco-related health risks has led PMI to pivot towards innovative smoke-free product lines.

Having launched more than a decade ago, IQOS has positioned itself as a market leader in smoke-free products, generating over $10 billion in annual net revenue. In a strategic move reflecting its commitment toward transitioning, PMI invested $16 billion in acquiring Swedish Match, primarily driven by the growth potential of its smokeless product, ZYN. This modern oral nicotine pouch has gained traction since its launch in 2017, representing a significant departure from the conventional tobacco business model. The historical roots of snus in Europe can be traced back over a century, but the resurgence of ZYN underscores a transformative moment within the industry.

Although nicotine delivery products still carry the potential for addiction, they contain fewer harmful particles and chemicals associated with diseases like cancer and heart disease. Stacey Kennedy, PMI’s President of North America and CEO, underscores the company's mission to encourage adult smokers to switch from cigarettes to scientifically validated alternatives. From humble beginnings in 2015, ZYN’s sales of just over $20 million are projected to soar to $23.6 billion by 2030.

The expanding market for smoke-free products has illuminated a path for Philip Morris to experience significant growth. According to company reports, revenue from smoke-free alternatives saw a 13.6% increase in the second quarter of 2024, while revenue from combustible tobacco grew by a modest 1.2%. More remarkably, the gross profit from smoke-free business surged by 15.6% as compared to only 1.8% from combustible products. The success of the smoke-free segment hinged on the IQOS user base, which expanded to approximately 30.8 million, indicating a substantial transition from traditional smoking methods.

The skyward trajectory of the smoke-free product lines is mirrored in the impressive figures shared during quarterly earnings calls. Despite historical health concerns and legal constraints that once hovered over PMI like a dark cloud, the company has successfully turned the page of its narrative. In the first three quarters of 2024, revenues reached $28.17 billion, marking a 7.8% increase compared to the previous year. Net income climbed to $7.64 billion, showcasing a staggering 35.9% year-on-year growth— all of which served to counteract previous apprehensions regarding the future of the company.

Delving into product performance, revenues from combustible tobacco generated net income of $17.39 billion, reflecting a modest 3.3% rise from previous periods. Conversely, the smoke-free segment yielded $10.53 billion in net income, an impressive increase of 16.4%. The pattern is replicated in gross profit figures, suggesting that PMI’s strategic pivot is yielding favorable results. Notably, ZYN has emerged as a significant growth driver, with demand surging within the United States, leading to a rise of nearly 40% in sales volume within the first nine months of 2024.

The company has ambitious plans to expand its manufacturing footprint, earmarking $600 million for a new ZYN production facility in the U.S. As ZYN continues its impressive growth trajectory, its recent expansion into additional markets such as Greece and the Czech Republic illustrates PMI's global aspirations. With projections estimating annual sales of 580 million pouches by 2024, the international appetite for these products is evident.

Management attributes PMI's strong quarterly performance to three pillars of growth: sales volume, pricing strategy, and a transition toward smoke-free product offerings. This headway is not strictly limited to product innovation, as it also embraces favorable pricing adjustments driven by increased costs— contributing a noteworthy 7.5 percentage points of growth to the overall performance.

By aiming for over half of its revenue from smoke-free products by 2025 or 2026 and exceeding two-thirds by 2030, PMI's strategy goes beyond transformation; it’s a holistic approach toward reshaping its identity. This potential rebranding illustrates the company's commitment to thriving in a post-tobacco landscape while reaping attractive returns for its investors through the decade’s changing perceptions of consumption.

Consequently, today’s Philip Morris is not just a tobacco company— it is in the midst of a reinvention, transitioning towards smoke-free alternatives while simultaneously re-establishing itself as a growth stock. Such quality growth renders favorable cash flow, allowing for sustainable reinvestment in long-term strategies while rewarding shareholders. By adhering to a robust policy of increasing dividends consistently for 17 years, Philip Morris is committed to returning capital to its investors, which is a hallmark of sound corporate governance and a shareholder-friendly culture.

Reflecting on America’s economic historical trends, tobacco retail sales barely declined between 1928 and 1932, affirming nicotine’s addictive nature. Even today, consumers exhibit persistence in seeking out their habits, highlighting the unchanging demand for tobacco products regardless of broader economic fluctuations. As the challenges mount for companies like Ford and Paramount Pictures, who are facing the test of ever-evolving markets, PMI maintains a dynamic advantage characterized by its addictive consumption pattern.

Investors have identified key factors contributing to Philip Morris's impressive long-term returns, noting high dividend payouts, a robust return on equity (ROE), and sustainable profit margins. Even amidst challenges, the potential for high returns remains bright, guided by a business model built on low capital expenditure, strong cash flow, and evergreen products appealing to an addictive consumer base.

Ultimately, the interplay between Philip Morris’s long-term yield and the fluctuating market sentiment encapsulates a profound lesson in investing: it’s not merely the growth rate that dictates success, but the expectation management in the eyes of investors. As potential risks fueled by legal concerns remain pervasive, the unrelenting demand for Philip Morris's income-generating capabilities demonstrates a revitalized growth trajectory. Consequently, this once-controversial company may emerge as an unexpected leader in long-term value creation—an enduring testament to the changing landscape of consumption and investment.