MENU

Is British American Tobacco plc Still A Buy After The 2013 FTSE Bull Run?

2013 has been the year in which even the most hardened stock market bears have admitted that we’re in a five-year bull market — and it’s not over yet.

Although the FTSE 100 has slipped back from the five-year high of 6,875 it reached in May, it is still up 8.0% this year, and is 52% higher than it was five years ago. As Christmas approaches, I’ve been asking whether popular stocks like British American Tobacco (LSE: BATS) (NYSE: BTI.US) still offer good value, after five years of market gains.

Back to basics

BAT’s share price has underperformed the FTSE 100 over the last five years, with a gain of just 30%. However, when BAT’s generous dividend is factored in, the picture changes. The tobacco firm has delivered an average total return of 17.5% per year since December 2008, compared to 12.3% for the FTSE 100 (total return is capital gain plus dividends).

Billionaire investor Warren Buffett says that one of the most important lessons he learned from value investing pioneer Ben Graham, is that “price is what you pay, value is what you get”.

As potential buyers of British American Tobacco today, we need to forget historic price movements and focus on the value that’s on offer today:

Ratio Value
Trailing twelve month P/E 14.6
Trailing dividend yield 4.4%
Operating margin 35.6%
Net gearing 147%
Price to book ratio 8.2

BAT’s 35.6% operating margin is a testament to its efficiency, and to the pricing power provided by its premium brands. Although BAT isn’t quite as cheap as it was a few years ago, it’s hard to deny that for income investors, a BAT’s 4.4% yield, and its track record of dividend growth, still offer good value.

Isn’t the tobacco business in decline?

Although BAT’s ‘stick volumes’ have dropped from 792bn in 2003 to 694bn last year, its profits have continued to rise, and 694bn cigarettes still equates to a lot of addicted customers.

I do think that BAT’s earnings and dividend growth are both likely to moderate over the next few years, and analysts’ consensus forecasts for 2014 seem to back this up:

Metric Value
2014 forecast P/E 13.6
2014 forecast yield 4.8%
2014 forecast earnings growth 6.3%
P/E  to earnings growth (PEG) ratio 2.3

These figures look good and suggest that BAT will be able to maintain its record of rising profits on falling volumes for some years to come — although I’d remain alert for any sharp rise in interest rates, that could cause the firm to divert money from share buybacks and dividends to debt repayments.

When picking stocks to provide a long-term income, it's important to test the quality of the dividend before you buy. Overall, while I think that BAT still has a lot to offer income investors, I do think there are better buys elsewhere.

To help you find the best dividends in today's market, the Motley Fool has just published a brand new report, "5 Golden Rules For Building A Dividend Portfolio". I reckon BAT meets at least four of these rules, but to decide for yourself, click here to download your free copy of this report immediately.

Roland does not own shares in British American Tobacco.