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.

Should you invest £1,000 in Sainsbury's right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Sainsbury's made the list?

See the 6 stocks

Created with Highcharts 11.4.3British American Tobacco P.l.c. PriceZoom1M3M6MYTD1Y5Y10YALL10 Jan 201910 Jan 2024Zoom ▾Jul '19Jan '20Jul '20Jan '21Jul '21Jan '22Jul '22Jan '23Jul '23Jan '242020202020212021202220222023202320242024www.fool.co.uk

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.

Like buying £1 for 31p

This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

See the full investment case

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

Young female business analyst looking at a graph chart while working from home
Investing Articles

After collapsing 28% today, are Bunzl shares too cheap to ignore?

A poor trading statement has sent Bunzl shares to multi-year lows. Could now be a good time to consider investing…

Read more »

Investing Articles

These 5 stocks could earn £1,600 of annual passive income in a £20,000 ISA

Harvey Jones shows how to generate a high and rising passive income by buying a balanced mix of high-yielding FTSE…

Read more »

Young woman holding up three fingers
Investing Articles

3 things I like about Greggs shares

Greggs shares have tumbled by more than a third over the past year. But this writer has no plan to…

Read more »

artificial intelligence investing algorithms
Investing Articles

Nvidia stock: beware the bear market rally

Andrew Mackie argues that investors should tread carefully before investing in Nvidia stock, as the worst of the sell-off could…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

Up 73% in one year, is this the best value stock in the FTSE 100?

A brilliant run of form suggests this FTSE 100 giant should no longer make the cut as a value stock.…

Read more »

Investing Articles

The best could yet be to come for UK shares! I’m buying these ones

Amid ongoing stock market turbulence, this writer's been adding selected UK shares to his portfolio. Here's why and what he…

Read more »

Top Stocks

4 UK stocks trading well below book value to consider buying

Sometimes, it pays to be contrarian: who says the UK market has priced a stock precisely right, anyway?

Read more »

Investing Articles

The S&P 500’s 12% off its highs. Is now a good time to buy US shares for an ISA?

Right now, a lot of British investors are wondering whether it’s a good time to buy US shares. Here, Edward…

Read more »