There’s one company in the FTSE 100 that I believe is so undervalued it could double an investment in the medium term.
This company has been relatively unaffected by the pandemic. In fact, it recently increased its revenue expectations for the year.
However, despite its positive outlook, investor sentiment towards the business has only deteriorated in 2020. This has pushed the stock price down to levels I believe are too good to pass up.
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The company is British American Tobacco (LSE: BATS). Ethical considerations aside, I believe this is one of the best-run businesses in the FTSE 100.
Even though it can’t advertise its primary product of cigarettes, and consumers are abandoning the goods in droves, the group has still managed to increase profits year after year.
This is incredibly impressive. Most companies struggle to achieve this kind of performance even without the sorts of restrictions under which British American operates.
The company’s performance this year is even more impressive. After initially expecting a high single-digit decline in cigarette sales, the organisation now believes volumes and sales will fall by a low single-digit percentage.
Coupled with price increases, management now reckons the group will be able to report a mid-single-digit percentage increase in earnings per share for the year.
Despite this growth, the FTSE 100 company continues to look cheap. The stock is trading at a forward price-to-earnings (P/E) multiple of less than 10. That’s significantly below its long-term average, which sits in the mid-teens.
At the same time, it looks desirable as an income investment.
Income investment
Shares in the global tobacco giant currently support a dividend yield of 7.3%, which is more than double the FTSE 100 average.
Usually, I’d be wary of such a high dividend yield. It’s typically a sign the payout is unsustainable, and could be cut in the near term. However, on this occasion, I’m confident the distribution is sustainable.
Figures show that British American’s annual dividend is covered 1.5 times by earnings per share. What’s more, in recent years, management has aggressively reduced the company’s outstanding borrowings. This has helped strengthen the balance sheet. It also provides additional financial flexibility to maintain the dividend.
Considering all of the above, I think it’s likely shares in the company can double investors’ money in the near term. A dividend yield of 7.3% suggests investors would see a 100% return on their money in 10 years, assuming no capital growth. With the shares trading at a discount of around 40% to their long-term average valuation, this seems unlikely.
As such, I believe that over the next few years, a combination of income and capital growth will yield high total returns for investors. A total return of more than 100% doesn’t seem unlikely based on the above.
