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

Investing Articles

£20,000 in savings? Here’s how I’d aim to turn that into passive income of £903 a month

Our writer shares one approach to passive income investing, spotlighting a quality FTSE 100 stock he recently added to his…

Read more »

Investing Articles

Great dividend stocks! Here’s the forecast for Associated British Food shares to 2027

Associated British Foods' shares have dropped in value this year. Does this present a dip-buying opportunity for dividend investors to…

Read more »

Investing Articles

Should I sell my FTSE All-Share index fund and buy a S&P 500 tracker instead?

Harvey Jones is wondering whether now is a good time to invest more money in the S&P 500, after a…

Read more »

Investing Articles

Should I buy dirt-cheap BT shares after the recent pullback?

BT shares were on the up but now they're sliding again after the board trimmed full-year guidance. Now Harvey Jones…

Read more »

Investing Articles

Up 28%, can the easyJet share price keep rising?

The easyJet share price has gained altitude over one year but plunged over five. Is now an attractive time for…

Read more »

British Isles on nautical map
Investing Articles

Should I buy more BAE Systems shares at 1,350p?

BAE Systems shares have had a fantastic run since early 2022, yet still don't appear overvalued. Is it now time…

Read more »

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

7% yield and a cheap valuation! Is this one of the best shares to buy this month?

Christopher Ruane has been looking for cheap shares to buy. This one has a 7% dividend yield, so is it…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

Should I buy National Grid shares for the big dividend before it’s too late?

This year's price weakness has left National Grid shares on what looks like a tempting valuation. I hope it doesn't…

Read more »