Since I turned 50 a while ago, a couple of major factors have been in play regarding my FTSE 100 investments.
First, the valuation discount of the UK’s leading index to its major international peers has stayed high.
Even when it recently broke through 8,000, it was trading at a one-year average price-to-earnings (P/E) ratio of around 13. At the same time, the US’s S&P 500 benchmark index was trading at a P/E of about 25.
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This extreme valuation mismatch has been evident to me ever since the 2016 Brexit decision. In my view it’s unfounded, but unfortunately hoping it could be different won’t make it come true.
In practical investment terms, this means to me that growth stock opportunities are fewer than they were before 2016. This may change over the next 10, 20, or 30 years. But I’m at a time in my life when I don’t want to hang around waiting for my investment returns.
The second factor is a positive flipside to this. The yield on a dividend-paying stock rises as its share price falls. Each year, the total dividend payment can also change, but in the year itself this equation holds good.
This means that because many FTSE 100 are making good profits that drive these high dividends, exceptional yields can be found.
Consequently, I’ve been focusing on identifying stocks that will generate big passive income returns for me. This should enable me to continue to reduce my working commitments and to live off the income from dividends.
A star in my high-yield portfolio
British American Tobacco (LSE: BATS) is one stock that perfectly fits the bill for me. With its 2023 dividend set at 230.89p a share, its yield has now gone up to 10%.
The recent price drop has added to the undervaluation of the stock that’s been evident to me for some time.
It now trades at a P/E of just 6. This is the lowest in its peer group, the average P/E of which is 12.3.
A discounted cash flow analysis using other analysts’ figures and my own shows the stock to be around 53% undervalued. Therefore, a fair value would be around £49.15.
This doesn’t guarantee that it will necessarily reach that price at any point, of course, But it underlines to me how cheap it looks.
Aside from the seemingly chronic undervaluation of FTSE 100 stocks, there are specific risks in the firm as well.
One is that its ongoing transition away from tobacco products to nicotine substitutes is delayed for some reason. Another is any litigation from the effects of its products in the past.
Huge passive income generator
At the current price of £23.10, I could buy 433 shares in the firm for around £10,000.
If I reinvested the dividends paid me back into the stock, I’d have £27,070 in total after 10 years. This would pay me £2,566 a year in dividends, or £214 each month, if the yield averaged 10% over the period.
On the same proviso, after 30 years I’d have £198,374 in total, paying me £18,803 a year, or £1,567 each month.
Given this, and its apparent undervaluation, I’ll be buying more of the stock very soon.
