No, it’s not recession proof, but who wouldn’t have taken a 25% decline in their industry in a year when the market overall declined 40%? To top it all off? On an equal weighted basis, this industry index offers a 6% dividend yield. If you held the index at the beginning of the year, you’d have been paid 4.5% for patiently riding out the recession without the pain of a 40% decline. 

So, what companies make up this index? Tobacco companies. cigarettes, smokeless tobacco, and stogies. One of the world’s oldest and simplest businesses. Say what you will about tobacco being a vice, there are few more shareholder friendly stocks than tobacco stocks. The AMEX Tobacco Index features include 8 major tobacco companies. Only one does not pay a dividend. Of the dividend paying businesses, all feature significant payout ratios (>30%). 

With increasing awareness about the health hazards related to smoking and smokeless tobacco, these businesses will not present you with the high growth prospects of some other stocks. That being said, this is an oligopolistic industry backed explicitly (or accidentally depending on who you talk to) by the government. Restrictions against marketing tobacco products severly handicap new brands, much less new market entrants. Heavy taxes make tobacco companies a golden goose to federal and state governments, so despite the hooting and hollering of attention grabbing politicians, it’s unlikely these businesses will be killed any time soon. Add in a captive (read: addicted) consumer and you have a business with the pricing power to defend revenue even in the face of a modestly declining market. 

While the tobacco market is declining in the U.S., tobacco usage around the world continue to thrive, particularly in Asia. A smart bet for one looking to play the industry is probably a paired buy of an industry leader in the United States - Altria (MO, 50% share), Reynolds America (RAI, 29%), or Lorillard (LO, 11%) - and a higher growth tobacco business either an internationally positioned business like Phillip Morris (PM) and British American Tobacco (BTI).

Another interesting route to hedge out risk to one of the oligopolistic leaders is to look for other marginal players who offer other kinds of differentiated tobacco products. One particular stock of interest is Star Scientific (STSI), a maker of “healthier” tobacco products. Its stock has actually tripled over the last year. 

Me? Well, being the yield hog that I am, I’ve picked up a few shares of Altria while I work out my ongoing “tobacco strategy.” An 8% dividend yield and a shareprice that completely discounts any growth in free cash flows - dividends seems reasonable to me. Yes, there’s debt on the balance sheet but this is a cash cow which should service debt handily for quite some time.