Since I turned 50 a while back, I’ve focused on buying stocks that pay high dividends.
I want to continue to reduce my working commitments, which means maximising income from my investments. I also don’t want to be waiting around for growth stocks to recoup any major price losses, as has happened before.
But any dividend stock I buy, needs to have an excellent core business, undervalued shares against their peers in my view, and a very high yield.
Consequently, I am looking to sell my holding in Lloyds (LSE: LLOY) and buy more of another holding. This may well be British American Tobacco (LSE: BATS) based on my three-pronged dividend stock selection strategy.
Share price potential
Using the key price-to-earnings (P/E) measurement, Lloyds currently trades at 6.4, against a peer group average of 6.1. So it looks overvalued against its peers.
British American Tobacco trades at a P/E of 6.2, against a peer group average of 12.2. So it looks very undervalued against its peers. This means I’m less likely to see my dividend gains wiped out by share price losses, in my view.
One clear victory for British American Tobacco so far.
Core business potential
Consensus analysts’ forecasts are for Lloyds earnings to grow by 0.7% a year to the end of 2026. Earnings per share are forecast to increase by 6% a year over that period. And return on equity is predicted to be 12% by the same point.
British American Tobacco is forecast to see its earnings increase by 57% a year to end-2026. Earnings per share is expected to increase by 53% a year over that period. And return on equity is predicted to be 16% by the same point. To me, this means it’s more likely to continue to be able to pay high dividends.
Another clear win for British American Tobacco.
This is not offset by greater risks for it than for Lloyds, in my view. True, one key risk for the tobacco firm comes from a delay in its ongoing transition from tobacco products to nicotine substitutes. Another is potential legal action for health problems caused by its products in the past.
Yet Lloyds faces declining profit margins as interest rates fall in the UK, as inflation drops. It also faces legal action for mis-selling car loans through its Black Horse insurance operation.
Passive income potential
Lloyds paid 2.76p a share in dividends in 2023, giving a yield on the current 49p share price of 5.6%.
British American Tobacco paid 230.89p in the same year, giving a yield on the present £23.48 share price of 9.8%.
A £10,000 investment now in Lloyds, with the dividends reinvested back into the stock, would give me a total of £30,569 after 20 years. This would pay me £1,661 a year, or £138 a month.
For British American Tobacco, it would be £70,430,paying me £6,549 ayear, or £546 a month.
These figures are based on the yields averaging the same over the period. They may go up or down as dividend payouts and share prices change.
This is another clear win for British American Tobacco – three out of three.
Consequently, I will use part of the proceeds from selling Lloyds shares to buy more of the tobacco firm’s stock.
