Given the ongoing lack of gains in the FTSE 100, my focus remains on making passive income from dividend stocks. In choosing such shares, I look at three key factors. First, the dividend yield; second, dividend cover; and third, business fundamentals.
I also like a stock that is trading at a significant discount to its recent high. This means I am less likely to lose passive income gains on adverse share price movements. I may even make good returns on the share price as well, over time.
FTSE 100 heavyweight British American Tobacco (LSE: BATS) certainly fits the bill at a knockdown stock price. It is at its lowest level since 1 December 2021, and down 31% from its 29 June 2022 recent high. This year, it has dropped 25%.
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Solid fundamentals
I also like that the stock drop is seemingly founded on a misconception. Namely, that smoking is a thing of the past and – therefore — so is a company with ‘tobacco’ in its name.
Certainly, in many developed markets, smoking has been on the decline for years, and that is likely to continue. This is a key risk for the shares. Another is lawsuits against the company for the damage to health created by its products.
However, there are many developed markets and emerging ones in which smoking is still popular. Its H1 2023 results showed that revenues for combustible (cigarette) products in Asia Pacific/Middle East/Africa offset declines in the US.
Additionally, in markets in which smoking has declined, the company is seeing good business in non-combustible (vaping) products.
Its ambition is to have 50m consumers of such products by 2030. The goal is to reach £5bn of non-combustible product revenues in 2025.
Last year, consumers of its non-combustible brands rose by 4.2 million, reaching 22.5 million. Revenue from these products accounted for 16.6% of its revenue in H1 — up 1.5% on 2022.
Overall in H1, revenue increased 4.4% to £13.4bn.
Serious passive income generator
So, the company is at a relatively low share price but is producing good results – two boxes ticked for me. The final two are dividend yield, and dividend cover ratio. A ratio above 2 is considered good, while below 1.5 may indicate the risk of a potential dividend cut.
In 2020, the payout was 210.4p per share, giving a yield of 7.8%. In 2021, it paid 215.6p (7.9%), and last year 217.8p (6.6%). The dividend cover ratios were 1.58, 1.53, and 1.71, respectively – all fine.
The current yield based on the share price of £25.28 is 8.6%. So, the last two boxes are ticked for me.
At this rate, a £10,000 investment now would make me £860 per year. Over 10 years, I would have made £8,600 in passive income, on top of my £10,000 investment.
This would not include further gains from any reinvestment of dividends or share price appreciation. It would also not account for any tax liabilities or share price falls.
I already have other holdings that offer good dividend yields and share price growth prospects. If I did not, I would buy these shares now for two key reasons. First, the possibility of the 25% share price loss this year being recouped over time. Second, the high passive income I could make.
