Personally, I don’t buy cigarette maker stocks, which means I haven’t looked closely at British American Tobacco (LSE: BATS) shares for some time. If I did buy them, I would have bought this FTSE 100 dividend stock ages ago.
It offers one of the highest yields on the index, while trading at a rock bottom valuation. This seems to be a permanent state of affairs, not one I’d expect to change.
How times change
The attitude to smoking has shifted dramatically in my lifetime. I remember my parents’ Christmas Day parties in the 1970s, when the neighbours filled our home with perfume and cigarette smoke. Today they’d be forced to puff away on the step, if they smoked at all.
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Smoking has declined in the west, as decades of health campaigns have done their bit, but it’s a different story in the developing world (at least for now).
The investment case for British American Tobacco is that it will take a greater share of a shrinking market, thanks to its strong brands and acquisition strategy. That seems to be holding good. Revenues totalled £24.49bn in 2018. By 2022, they had climbed to £27.66bn. That’s cumulative growth of 12.9%, which is steady if not spectacular.
Over the same five-year period, pre-tax profits increased from £8.35bn to £9.23bn. Cumulative growth here is 11.66%.
Throughout that period, the dividends have increased steadily, which is exactly what investors want to see. British American Tobacco paid 203p per share in 2018, by last year that had edged up to 217.8p. That’s a cumulative 7.29%. Again, steady but not spectacular.
Few long-term investors will complain as the shares now yield a stunning 8.3%, covered 1.7 times by earnings. The forecast yield is even higher at 9.3%, with cover remaining strong at 1.6 times. Consensus suggests management will increase the dividend per share to 242p in 2023, a rise of 11.1%.
Based on that rate, I’d need to buy 496 shares to generate my income target of £1,200 over the next year. At today’s share price of £26.26 that would cost me £13,025.
A high and rising income
My maximum limit for any single stock purchase is £5,000, to maintain diversification, but given the relative security of the British American Tobacco yield, I would be tempted to make an exception here. If I bought tobacco shares, that is.
Even a £5,000 investment would still generate income of more than £450 a year. With the dividend per share forecast to hit 2.54p in 2024, that would rise to £485 next year and with luck carry on climbing after that. This is a stock to hold for the long term, to give those dividends time to compound.
Dividends are never guaranteed, of course. However, with British American Tobacco, the bigger risk is to my capital. The share price is down 31.62% over five years and 23.88% over the last 12 months. This is supposed to be a defensive sector, but that hasn’t protected investors from the wider market sell-off.
The company does have growth opportunities, primarily in vaping, but the real attraction is the income. I’d love to get a piece of that, but investment decisions are highly personal, and I’m going to pass in this instance. Shame.
