When I’m looking for shares that will generate passive income for me, I want to pick stocks with good dividend yields. I find that tobacco shares have historically been a profitable place to look.
However, it’s important to note that a too-high dividend yield can sometimes be a problem down the line. Here are the two UK tobacco companies I’d choose for making passive income.
Imperial Brands
Imperial Brands (LSE: IMB), formally known as Tobacco Group plc, is the fourth-largest international cigarette company. Investing in this tobacco share could generate considerable passive income for me with a dividend yield of 8.63% at the time that I’m writing.
Before the outbreak of the pandemic, Imperial Brands had been able to sustain a positive dividend growth. Between 2014 and 2020, the dividend yield saw a consistent growth of 10%.
In 2020, we witnessed a significant decline in dividends as the company sought to deal with increasing debt. But in its May 2021 interim results, the company reported a 1% increase in dividend yield again.
While I don’t like to see a drop in dividends, I’m of the opinion that dividend reduction isn’t necessary a bad thing, especially when the company is devaluing to address net debt.
In my opinion, based on the company’s positive revenue and profit, I trust that Imperial Brands has a good recovery strategy in place and will be returning sustainable dividends in the future.
British American Tobacco
British American Tobacco (LSE: BATS) is the largest international tobacco company in terms of net sales. The company has reported a 7% increase in dividend growth since 2010 and as I’m writing it has a 7.8% dividend yield. The dividend last July was at 53.9p.
On the other hand, the BATS share price has not been anything to shout about over the past year. It dropped by almost 10% in the last 12 months, but has since recovered somewhat.
However, the company has been reinforcing its sustainable dividend yield with good earnings. BATS reported a 10.5% increase in revenue in its FY2020 report.
I feel confident that I can make passive income from a share when its good dividend yield is backed up with consistent revenue and profit growth.
The bearish case for tobacco shares
Both of these tobacco companies will face the issue of regulation over the amount of nicotine in their products. I’m concerned that if these laws are implemented it could affect future sales. This is because of the addictive elements in the substance. BATS have already started venturing out with alternatives such as vapour-based cigarettes and new modern oral products. But I’m unsure if consumers will be satisfied with these products.
Would I buy for passive income?
Tobacco companies could face issues with regulation in the future and will need to find a successful solution to adapt. However, BATS and Imperial Brands both have enticing dividend yields of around 8%.
This is why I’d buy these tobacco shares wholly as an income play. With a three-year outlook, I believe I could make a decent return from them.
