Ten Percent Fewer Cigarettes, Record Profit: How the Taxman Doubles Big Tobacco’s Pricing Power — and Where the Math Starts to Break

Altria sold ten percent fewer cigarettes in 2025 than the year before. Its smokeable products segment earned $11.06 billion of adjusted operating income at a 63.4 percent margin — both records. Philip Morris International has promised shareholders nine to eleven percent more earnings per share in 2026, in an industry whose product has been losing customers for four decades. None of this is a contradiction. It is arithmetic — and once you work through it, you understand why every excise increase enlarges rather than shrinks the manufacturers’ pricing power, why the same arithmetic is starting to fail in the United States, and why the market pays 22 times earnings for Philip Morris but only twelve for Altria.

Tobacco is the rare business whose end product has been in structural decline for forty years and which nevertheless ranks among the best investments in stock-market history. When Jeremy Siegel reconstructed the returns of every original S&P 500 member for “The Future for Investors,” the best performer from 1925 to 2003 was not IBM and not Coca-Cola but Philip Morris, at 17 percent a year with dividends reinvested — 7.3 points a year better than the average stock. A thousand dollars became more than a quarter of a billion. This article lays out the mechanism behind that record using the numbers from 2025 and 2026, and names the three conditions without which it stops working.

The arithmetic that turns a shrinking market into a growth business

A manufacturer’s revenue is price times volume. In almost every industry that is a trap: raise price ten percent and you lose more than ten percent of volume, because customers switch to a competitor or go without. For cigarettes, the response of demand to price has been measured for decades. The WHO’s International Agency for Research on Cancer summarized the literature for high-income countries in 2011: price elasticity clusters around −0.4. A European panel study published in 2023 landed on the same figure, with a confidence interval of −0.67 to −0.24. In plain English, a ten percent price increase costs four percent of volume.

That alone would make a remarkable business. Ten percent more price on four percent less volume is 5.6 percent more revenue — and because four percent less volume also means four percent less leaf, paper, filter and packaging, profit grows faster than revenue. But the real arithmetic is better still, and the reason is the government.

The taxman as silent partner: why excise doubles the price lever

The −0.4 elasticity refers to the shelf price. The manufacturer receives only a fraction of it. In the United States, federal excise is $1.01 per pack and the average state excise is $2.01; on a volume-weighted average price of about $9.95, excise taxes make up roughly 31 percent of what the customer pays. In Germany, a pack of twenty costs €9.00 to €9.40 in 2026, and since January 1 each cigarette carries 12.28 cents of tobacco tax plus 19.84 percent of the retail price, with 19 percent VAT on top. On a €9.20 pack that is about €4.28 of tobacco tax and €1.47 of VAT — €5.75, or 62.5 percent of the price. Manufacturer, wholesaler and retailer share the remaining €3.45; net of the retail margin the manufacturer keeps roughly €2.50, a little over a quarter of the shelf price. On budget brands the tax share rises to 75 percent.

Here is the lever. If the German manufacturer wants ten percent more net revenue per pack — 25 cents — the shelf price does not need to rise ten percent. It only needs to rise far enough that 25 cents remain after the ad valorem excise and VAT take their share of the increase. Of every additional euro at the register, 19.84 cents go to tobacco tax and about 16 cents to VAT; roughly 64 cents remain. To net 25 cents, the manufacturer needs a shelf increase of about 39 cents, or 4.2 percent on €9.20. At an elasticity of −0.4, that costs 1.7 percent of volume. Ten percent more revenue per pack on 98.3 percent of the units is a little over eight percent more net revenue — on a falling unit cost.

Per-pack arithmetic (Germany 2026)	Starting point	Manufacturer +10 % net
Shelf price	€9.20	€9.59 (+4.2 %)
Tobacco tax (12.28 ct/stick + 19.84 %)	€4.28	€4.36
VAT 19 %	€1.47	€1.53
Trade + manufacturer	€3.45	€3.70
of which manufacturer net (approx.)	≈ €2.50	≈ €2.75
Volume effect at elasticity −0.4	—	−1.7 %
Manufacturer net revenue	100	≈ 108

That is the real point: the higher the tax share of the shelf price, the smaller the percentage increase the customer sees for any given increase in the manufacturer’s take — and the smaller the volume loss. A government that raises excise to cut consumption simultaneously dilutes the customer’s perception of the manufacturer’s price. A company that owns a quarter of the shelf price can raise its own price four times as hard as a company that owns all of it before the customer notices the same percentage jump.

Now run the same exercise in the United States. With excise at 31 percent of the price, the manufacturer’s share is far larger — and the lever far smaller. A ten percent increase in the manufacturer’s price arrives on the shelf as a five to six percent jump, against a little over four percent in Germany. That is one of the reasons the same pricing strategy produces such different results in the two markets, as the numbers below show.

Why the tax steps are known years in advance — and what that does for planning

The legislature’s second gift is predictability. Germany’s Tobacco Tax Modernization Act of 2021 fixed the excise schedule in annual steps through 2027. Every manufacturer knows today what the 2027 rate will be and can wrap its own price rounds around it: the tax step supplies the occasion, the manufacturer adds a few cents for itself, and the customer sees a single price increase that he attributes to the state. The final step on January 1, 2026 added 20 to 30 cents to a pack — a moderate price round by the standards of any other consumer category, except that the pack already cost nine euros.

Austria follows the same path in 2026. The fixed component rises from €83.50 to €85.50 per 1,000 cigarettes, the ad valorem component stays at 32 percent of the retail price, and packs go up ten to 40 cents. More notable is what has been taxed since April 2026: nicotine pouches and e-liquids are folded into the tobacco monopoly and become excisable. The government expects tobacco tax receipts to rise from €2.2 billion to €2.3 billion in 2026 and another half a billion from the new categories by 2029. For manufacturers, the message is that the substitute products are acquiring a state-mandated price floor — and with it the same lever the cigarette has.

At the European level the next step is already drafted. On July 16, 2025 the European Commission proposed a revision of the Tobacco Taxation Directive that would raise the minimum fixed excise on cigarettes from €64 to €215 per 1,000 sticks and introduce, for the first time, minimum taxes on e-cigarettes, heated tobacco and nicotine pouches — for pouches 25 percent of the retail price from 2030 and 50 percent from 2032. The proposal requires unanimity in the Council, and member states are fighting mostly over the pouches. For Germany and Austria, whose rates already sit far above the current minimum, little would change; for the low-tax countries of southern and eastern Europe it would be a price shock. Whether it passes is open. That it would act on the decline rate if it did is not.

Proof in the numbers: Altria 2025

Altria is the model in its purest form, because the company operates almost exclusively in the United States and cigarettes dominate. Its 2025 results read like an illustration of the arithmetic above — with one important deviation, which we come to next.

Altria 2025	Figure	Change
Net revenues	$23.28 billion	−3.1 %
Revenues net of excise taxes	$20.14 billion	−1.5 %
Domestic cigarette shipments	61.8 billion sticks	−10.0 % (−9.5 % calendar-adjusted)
Estimated industry decline	—	−8 %
Smokeable net price realization	—	+8.4 %
Smokeable adjusted operating companies income	$11.06 billion	margin 63.4 % (+1.8 pts)
Marlboro share of total category	40.5 %	−1.2 pts
Discount segment share	31.8 %	+2.2 pts
Adjusted diluted EPS	$5.42	+4.4 %
Cash returned to shareholders	$8.0 billion	$7.0 bn dividends + $1.0 bn buybacks
2026 guidance (adjusted EPS)	$5.56–5.72	+2.5 % to +5.5 %

Two rows of this table explain the model better than any theory. First: ten percent less volume and 8.4 percent more price produce a decline in revenue net of excise of only 1.5 percent. Second: the operating margin of the cigarette business rose 1.8 points to 63.4 percent despite — or because of — the volume loss. A cigarette manufacturer has almost no fixed costs to spread over fewer units; the factories were depreciated decades ago, advertising is largely banned, and research in the core business is unnecessary. What disappears with volume is variable: leaf, paper, logistics. What remains is price.

Earnings per share grew 4.4 percent, faster than operating income, because Altria retired 17.1 million shares for $1 billion during the year. That is the second engine, and we return to it below. In August 2026 the board raised the dividend for the 60th time in 56 years, by 4.7 percent to $1.11 a quarter — $4.44 a year, a 6.4 percent yield at a share price near $69.

Where the arithmetic starts to break: the United States

Now the deviation. Apply the −0.4 elasticity to Altria’s 8.4 percent price increase and you expect a volume loss of three to four percent — not ten. Since 2023 the U.S. market has stopped behaving like the textbook. Altria estimates the industry declined eight percent in 2025 and 6.5 percent in the fourth quarter. Management names three reasons, and none of them is pure price elasticity.

The first is substitution into illicit products. About 70 percent of the American e-vapor market, by Altria’s estimate, consists of unauthorized, mostly flavored disposables that evade the FDA’s authorization process and are lightly taxed or not taxed at all. The total e-vapor market grew roughly 30 percent in 2025, after more than 50 percent in 2024. An elasticity of −0.4 describes a smoker whose alternative is quitting. It does not describe a smoker whose alternative is a cheaper, untaxed nicotine product at the same gas station. What is being measured there is not price elasticity but cross-price elasticity — and that is several times higher.

The second is the shift within cigarettes. The discount segment gained 2.2 share points in 2025 to 31.8 percent while Marlboro lost 1.2. Altria is answering with its own value brand, Basic, deployed against competitors in roughly 30,000 stores using what the company calls revenue growth management analytics, and it speaks openly of “severe economic pressures” on its consumers. This is the point where pricing power becomes price perception: a smoker who trades Marlboro for a brand two dollars cheaper has not cut his consumption, but he has cut the manufacturer’s revenue per stick by a third.

The third is the low tax share itself. Because only 31 percent of the U.S. price is excise, every manufacturer increase arrives almost undamped as a visible jump on the shelf, and the cumulative increases of the past five years have pushed a pack of Marlboro above twelve dollars in some states. The lever that damps the price in Germany is largely absent in the United States — what remains is raw elasticity, sharpened by substitutes.

That is the honest reading of the American numbers: the model still worked in 2025, but it paid for the result with far more volume than in the past. Altria’s guidance of only 2.5 to 5.5 percent earnings growth for 2026 — at a share price of roughly twelve times expected earnings — is the market’s verdict on that.

Germany: why volume did not fall in 2025

The German market supplies the counterexample. According to the Federal Statistical Office, 66.4 billion cigarettes were taxed in 2025 — 0.2 percent more than in 2024, after 2024 had already brought a 3.5 percent increase. The long-run trend is unambiguous, with 146.5 billion sticks in 1991; but short-run stability at a pack price above nine euros is exactly what the arithmetic predicts when annual price increases stay in the two-to-four percent range. Tobacco tax receipts rose to €16.2 billion in 2025 from €15.6 billion — the state earns from the same mechanism as the manufacturer.

Stable volume alongside rising prices does have an uncomfortable component in Germany: roll-your-own. Some 24,864 tonnes of fine-cut tobacco were taxed in 2025, 1.2 percent less than the year before, but still the escape volume into which price-sensitive smokers have been migrating for years. The 2021 law raised the tax on fine-cut deliberately faster than on cigarettes to close that gap, and the figures suggest the migration is stalling. For manufacturers that serve both categories it is revenue-neutral; for a pure cigarette maker it is customers coming back.

The lesson from Germany is not that cigarettes have a future there. The lesson is that a high tax share, small predictable steps and a largely controlled market for substitutes keep elasticity near the textbook value — while a low tax share, large price jumps and an unregulated vape market double it. Both countries raise the price. The difference is what the smoker can buy instead.

Philip Morris International: same arithmetic, different result

Philip Morris International sells outside the United States — in 180 markets where the tax share looks more like Germany’s than America’s. Its 2025 results and first half of 2026 show how differently the same strategy works there.

Philip Morris International	2025	Q2 2026
Net revenues	$40.6 billion (+7.3 %)	$11.2 billion (+10.4 %, +7.6 % organic)
Cigarette shipments	607.4 billion (−1.5 %)	156.9 billion (+1.1 %)
Combustible pricing	+$1.54 billion variance	+10.0 % (“exceptional”)
Heated tobacco units (IQOS)	155.1 billion (+11.0 %)	41.8 billion (+7.6 %)
Oral nicotine, total	879.6 million cans (+36.6 %)	5.1 billion pouches (−1.2 %)
ZYN, United States	+37 %	2.9 billion pouches (+1.8 %)
Smoke-free share of net revenues	41.5 %	42.0 %
Adjusted diluted EPS	$7.54 (+14.8 %)	$2.20 (+15.2 %)
2026 guidance	—	$8.26–8.41 (+9.5 % to +11.5 %)

PMI’s cigarette volume fell 1.5 percent in 2025, not ten, and actually rose 1.1 percent in the second quarter of 2026 — on a pricing variance of ten percent that the company itself calls exceptional. Combustible net revenue grew 2.5 percent in 2025 and combustible gross profit 5.2 percent. That is the arithmetic from the first section in its pure form: the excise lever damps price perception, the substitutes are regulated and taxed in most markets, and where they are not, the leading substitute — IQOS, with about three quarters of the global heated-tobacco market — belongs to the same company.

That last point is precisely why Philip Morris International, at a share price near $191, trades at 22 to 23 times expected 2026 earnings while Altria trades at twelve. The market is not paying for the cigarette; it is paying for the fact that substitution happens inside the company. Smoke-free products delivered 41.5 percent of net revenues and nearly 43 percent of gross profit in 2025, and in 27 markets they exceed half of revenue. A smoker who moves from Marlboro to IQOS remains a customer. A smoker who moves from Marlboro to an untaxed disposable vape in Ohio is lost to Altria.

The counterargument embedded in PMI’s valuation

A premium of ten earnings multiples assumes the growth story holds. And here the first half of 2026 has produced a crack that should not be overlooked. ZYN, the American nicotine pouch, was the company’s showpiece in 2025 with 37 percent growth. In the second quarter of 2026 shipments grew 1.8 percent, the company describes retail offtake as “flat to slightly growing,” and the total oral business shrank 8.8 percent in the first half. PMI blames an “uneven competitive landscape” — which in industry language means competitors are cutting price. Altria reports that category pricing fell twelve percent year over year while its own brand on! managed a three percent increase; BAT’s Velo Plus reached the number-two position within a year of launch.

PMI is responding with new variants at a lower price per pouch, heavier investment in the second half, and the FDA’s first modified-risk authorization for a nicotine pouch, covering 20 ZYN variants. That may turn the trend. But the core logic of this article does not yet apply to pouches: the tax share is low, the brands are young, loyalty is thin, and competition runs on price. Everything that makes the cigarette a cash machine — a high tax share, banned advertising, fossilized market shares — is missing from the growth business. The market pays PMI for the bet that the pouch category eventually takes on the same structure. Seen that way, Austria’s pouch tax and the Commission’s proposal are not a threat; they are the beginning of exactly that structure.

The second engine: distribution and reinvestment

Siegel’s 17 percent a year cannot be explained by the operating business alone; Philip Morris did not grow earnings 17 percent a year for 78 years. The rest is the reinvestment of dividends into a stock the market persistently underpriced — because of the litigation risk of the 1990s, because of regulatory risk, because so many portfolios exclude it. An investor who reinvests a six percent dividend yield into a stock trading at twelve times earnings buys an eight percent earnings yield with every payment. The model works as long as the payout is covered — which is exactly why coverage is the most important metric in the sector.

Altria funded $7 billion of dividends and $1 billion of buybacks in 2025 from roughly $13 billion of adjusted operating companies income across its smokeable and oral segments. Philip Morris pays $5.88 a share against expected earnings of $8.26 to $8.41, a payout ratio of roughly 70 percent. British American Tobacco, on a combustibles volume decline of 8.1 percent in 2025, achieved price/mix of 9.1 percent — up from 7.4 percent the year before — and reaffirms an algorithm of three to five percent revenue growth and five to eight percent adjusted EPS growth, with 2026 at the lower end. All three run the same mechanism; the market values each differently.

As of September 11, 2026	Philip Morris Intl.	Altria	BAT (ADR)
Share price	$191	$69	$55
Market capitalization	≈ $298 billion	≈ $115 billion	≈ $119 billion
Forward P/E	≈ 22–23	≈ 12	≈ 10–11
Dividend yield	3.1 %	6.4 %	6.0 %
Cigarette volume 2025	−1.5 %	−10.0 %	−8.1 %
Price/mix	+10 % (Q2 2026)	+8.4 %	+9.1 %
2026 EPS growth (guidance)	+9.5 % to +11.5 %	+2.5 % to +5.5 %	lower end of +5 % to +8 %

What twelve times and 22 times earnings each assume

For a business whose cash flow grows or shrinks at a constant rate, the fair multiple fits on one line: value divided by next year’s cash flow equals one divided by the difference between the cost of capital and the growth rate. Assume a nine percent cost of capital for a tobacco company — a premium to the market for regulatory and litigation risk — and the table below follows. It is deliberately rough, but it shows how much decline the market has priced in at each share price.

Perpetual cash-flow growth	Fair multiple (k = 9 %)	Corresponds to
−5 % a year	7.1	U.S. cigarettes with no replacement business
−3 % a year	8.3	—
0 %	11.1	≈ Altria, BAT today
+3 % a year	16.7	—
+5 % a year	25.0	≈ Philip Morris International today

Altria at twelve times therefore assumes that cash flow roughly stagnates forever — that price and buybacks just offset the volume loss. After the 2025 numbers that is neither pessimistic nor generous; it is an extrapolation. Philip Morris at 22 times assumes perpetual growth of four to five percent, close to its own target of six to eight percent organic revenue growth through 2028, but it requires the smoke-free business to reaccelerate after the ZYN half-year. The ten-multiple gap is the price of in-house substitution. Whether it is justified depends less on the cigarette than on whether a nicotine pouch ever acquires the price structure of a cigarette.

Bull and bear scenarios

Scenario	Assumptions	Consequence
Bull case	Tax share in Europe keeps rising (EU directive), pouches are taxed and regulated, illicit vapes are pushed back in the U.S., price realization holds at six to nine percent, volume decline normalizes to three to five percent	Altria returns to mid-single-digit growth and re-rates toward 14–15 times; PMI delivers 9–11 % EPS growth and keeps its premium
Base case	U.S. volume −7 to −9 % a year, price +7 to +8 %, discount share keeps growing; international volume −1 to −3 %, price +6 to +8 %; pouches grow but under price pressure	Altria stagnates on a high payout, total return ≈ dividend plus buyback (7–8 %); PMI grows 7–9 %, multiple holds or drifts lower
Bear case	U.S. volume −12 % or worse, pricing power breaks (discount above 35 %), a menthol ban arrives, pouch prices keep falling, the EU minimum tax fails and low-tax countries remain the gateway for smuggling	Altria has to cut its payout ratio and the multiple falls to 8–9; PMI loses its growth premium and re-rates to 15–16 — roughly 30 % of downside

What stands out in this table is that the largest downside does not sit with Altria, even though its volume is falling fastest. At twelve times earnings most of the damage is already priced; the stock trades closer to the bear case than the bull case. Philip Morris carries the valuation risk, because its premium depends on a business that does not yet have the cigarette’s mechanics. The supposedly riskier stock is the one with less to lose.

Practical notes for investors

Three points matter for anyone expressing this thesis through the listed companies. First, tax treatment of the income. For U.S. investors, Altria and PMI dividends are qualified dividends, taxed at long-term capital-gains rates in a taxable account, and in an IRA they compound untaxed — which is where a six percent yield reinvested at twelve times earnings does its best work. BAT and Imperial Brands are British companies whose dividends carry no UK withholding tax, but the ADRs charge custody fees that come out of the dividend; European investors holding Altria or PMI face a 15 percent U.S. withholding under treaty, creditable against domestic tax, so the net burden is the same but the paperwork is not.

Second, currency. For a non-dollar investor, a thesis built on a six percent dividend and two to three percent of buybacks can lose its entire annual return to a single year of dollar weakness; whoever holds the stock as a bond substitute holds a foreign-currency bond. For U.S. investors the mirror image applies to BAT and Imperial, which report and pay in sterling. Third, exclusion. Most sustainable funds and many institutional mandates screen out tobacco categorically. That is why the sector is structurally cheaper than comparable consumer-staples companies — and also why the discount will not go away. Whoever buys it, buys it permanently; the return comes from the distribution, not from a re-rating.

The three conditions of the arithmetic

The pricing power of tobacco companies is not a property of their brands. It is the product of three conditions that can be checked one by one. The first is elasticity: about −0.4 as long as the smoker’s alternative is quitting — and double that as soon as the alternative is an untaxed nicotine product on the same shelf. The second is the tax share: the higher it is, the smaller the visible price jump per unit of manufacturer revenue, which is why Germany and Austria at more than 60 percent are a better environment for price increases than the United States at 31 percent. The third is competitor discipline: it holds as long as advertising is banned, market shares are fossilized and the discount brands sit in the same hands — and it breaks in a young category like nicotine pouches, where prices fell twelve percent in 2025.

Altria showed in 2025 that the arithmetic still delivers a record profit on a ten percent volume loss, and the market showed with a multiple of twelve that it no longer trusts it. Philip Morris International showed that outside the United States the arithmetic still works without compromise, and the market pays 22 times earnings for the expectation that it can be transferred to the next product. Both can be right. An investor in the sector only needs to know which of the three conditions he is actually buying — and that the regulator who tries to reduce consumption with every tax step raises, with that same step, the pricing power of the companies that sell it.