A 9.7% yield but down 28%! Time for me to buy this hidden FTSE gem?

This FTSE 100 heavyweight yields 9.7%, is very undervalued against its peers, and made a reported operating profit of £5.9bn in H1 2023 alone.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Long-term vs short-term investing concept on a staircase

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Shares in FTSE 100 heavyweight British American Tobacco (LSE: BATS) have dropped 28% in the last 12 months. Given that yields rise as share prices fall, this has brought its payout up to a stunning 9.7%.

Only a handful of FTSE stocks have dividends over 9%, and this has put it firmly on my investment radar.

Now in my mid-50s, I am focusing more on dividend shares rather than growth stocks. The older I get, the less time I want to wait for a stock to recover from any shocks.

Undervalued giant

That said, a major price drop in a high-yielding stock could wipe out any gains made in dividends. So, any dividend stock I buy should offer very good value to lessen the chances of a further major price fall.

Starting with the key price-to-earnings (P/E) ratio, I see the company is currently trading at just 6.1.

This is very cheap compared to the peer group average of 11.4. The group comprises Imperial Brands at 7, Altria Group at 8.5, and Philip Morris International at 18.6.

discounted cash flow analysis shows the stock to be around 67% undervalued at its present price of £23.73.

Therefore, a fair value would be around £71.90, although this does not necessarily mean it will ever reach that level.

Is the business solid?

The declining popularity of smoking in developed markets has affected the company’s tobacco business overall. Indeed, its stock slide in December followed news of a £25bn impairment charge on some of its US cigarette brands.

However, the firm is transitioning to non-combustible nicotine products (including vapes) to deal with this change in attitudes.

Its H1 2023 results showed overall reported profit from operations rising by 61.4% from H1 2022 – to £5.935bn.

Reported revenue increased 4.4%, with ‘New Category’ non-combustible product revenues up 26.6%.

This is in line with the company’s target to generate at least £5bn in revenues by 2025 from these new products. By 2035, it believes at least half its revenues will come from New Category products.

A risk in the stock is that the timing of this switch away from tobacco products slips. Another is its debt level — around £38bn (after accounting for its cash reserve).

The high level of free cash flow in its earnings means it can pay this down with relative ease currently. However, it is something to keep an eye on.

A huge passive income generator

The company paid a 230.885p per share dividend last year, giving a yield of 9.7%.

If I invested £10,000 now in the stock, I would make £970 this year. Over 10 years, I would have £9,700 to add to my £10,000, if the yield averaged the same.

However, if I reinvested those dividends – ‘dividend compounding’ — rather than spending them, I would have £25,239 after 10 years.

The only reason I am not buying the stock today is that my high-yield portfolio is full. If this was not the case, I would have no qualms about buying it right now.

Its yield is exceptional, and I think its share price will move higher over time in line with its peers. This process should also be boosted by its ongoing business transition.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Simon Watkins has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco P.l.c. and Imperial Brands Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Closeup of "interest rates" text in a newspaper
Investing Articles

Here’s why 2025 could give investors a second chance at a once-in-a-decade passive income opportunity

Could inflation hold up interest rates in 2025 and give income investors a second opportunity to buy Unilever shares with…

Read more »

Investing Articles

As analysts cut price targets for Lloyds shares, should I be greedy when others are fearful?

As Citigroup and Goldman Sachs cut their price targets for Lloyds shares, Stephen Wright thinks the bank’s biggest long-term advantage…

Read more »

Investing Articles

Is passive income possible from just £5 a day? Here’s one way to try

We don't need to be rich to invest for passive income. Using the miracle of compounding, we can aim to…

Read more »

Middle-aged black male working at home desk
Investing Articles

If an investor put £20k into the FTSE All-Share a decade ago, here’s what they’d have today!

On average, the FTSE All-Share has delivered a mid-single-digit annual return since 2014. What does the future hold for this…

Read more »

Hand of person putting wood cube block with word VALUE on wooden table
Investing Articles

One FTSE 100 stock I plan to buy hand over fist in 2025

With strong buy ratings and impressive growth, this FTSE 100 could soar in 2025. Here’s why Mark Hartley plans to…

Read more »

Investing For Beginners

If a savvy investor puts £700 a month into an ISA, here’s what they could have by 2030

With regular ISA contributions and a sound investment strategy, one can potentially build up a lot of money over the…

Read more »

artificial intelligence investing algorithms
Investing Articles

2 top FTSE investment trusts to consider for the artificial intelligence (AI) revolution

Thinking about getting more portfolio exposure to AI in 2025? Here's a pair of high-quality FTSE investment trusts to consider.

Read more »

Young Asian woman with head in hands at her desk
Investing Articles

Do I need to know how Palantir’s tech works to consider buying the shares?

Warren Buffett doesn’t know how an iPhone works. So why should investors need to understand how the AI behind Palantir…

Read more »