As consumers, we’re conditioned into thinking certain things, in a certain way.
For instance, we all correctly think that a major factor in petrol prices being so high in the UK is government duty and taxation. Similarly, we all believe that cigarette prices have increased to the extortionate amount of around £8.50 per packet of 20 as a result of government duty increases, right?
Well, we may all believe that but research from the University of Bath shows, in actual fact, that between 2006 and 2009 about half of total price rises on cigarettes were due to tobacco companies simply putting up their prices. The other half was, of course, increases in duty but the tobacco companies should really be blamed by smokers as much as they currently blame the government.
Indeed, the research has been released at a time when tobacco companies are complaining about the increased cost of cigarettes and how it causes smuggling and the use of illegal cigarettes. Tobacco companies argue that duty increases are counter-productive, since people still smoke roughly the same number of cigarettes but, by using illegal rather than legal tobacco, the government is collecting no duty and running the risk of higher healthcare costs from unregulated products further down the line.
Clearly, the tobacco companies are either not as concerned about smuggling as they make out or are unaware that they themselves have been as much to blame as the government for higher prices.
Of course, price rises are (in reality) good for tobacco companies. Certainly, volumes of cigarettes smoked will at best remain flat if prices go up. However, this is more than offset by higher margins from higher prices.
Furthermore, there seems to be no limit on how high tobacco companies can go with price rises. When cigarettes were less than half their current cost, the same proportion of adults in the UK smoked (around 20-21%) as today. In addition, the cost of smoking in countries other than the UK remains relatively less versus median incomes (than in the UK), meaning there is more scope for price increases across the globe.
Clearly, there is potential for tobacco companies and my top pick in the sector is British American Tobacco (LSE: BATS) (NYSE: BTI.US). As someone who is frustrated by low savings rates, the current yield of 4% comes in very handy indeed.
Couple that with the potential to increase margins and deliver impressive and highly visible earnings growth and it is clear to see why British American Tobacco is a stock we should be buying.
Of course, you may be looking outside of the tobacco sector for an addition to your portfolio. If you are, The Motley Fool has come up with a shortlist of its best ideas called 5 Shares You Can Retire On.
It’s completely free to take a look at the shortlist and I’d recommend you do so. Click here to view those 5 shares.
> Peter does not own shares in British American Tobacco.