The index of FTSE 100 shares includes some of the largest companies in the country. Large and long-established companies can offer limited growth prospects. But what they may lack in growth potential, some can offer in potential income appeal.
One such share is tobacco maker Imperial Brands (LSE: IMB). Here’s how I would invest £1,000 in Imperial Brands today and hope to see my capital double in less than a decade – just by sitting back and letting it grow.
Imperial Brands yield
What’s important in this example is Imperial’s dividend. As a tobacco manufacturer, the company is able to benefit from regular customer demand. Input costs are fairly low, but owning premium brands such as John Player Special and West gives Imperial pricing power. However, even considering the emergence of modern tobacco products such as vaping, there are limited growth opportunities on which a tobacco company can spend its profits. Last year, for example, net capital expenditure of £274m represented under 2% of Imperial’s £14.4bn of revenue.
That means that tobacco companies such as Imperial tend to throw off large amounts of free cash. That can be used to fund dividends – in Imperial’s case, to the tune of £1.8bn last year. Even after cutting its dividend in 2020, Imperial currently yields 8.6%. That is one of the highest yields of any FTSE 100 share.
The power of compounding
By putting £1,000 into Imperial today, I would hope to have £1,086 a year from now. If I reinvested the dividends each time I got them, my capital ought to grow faster. So in the second year, for example, I would be looking at 8.6% of £1,086, not just £1,000. That could continue year after year. Within nine years, if the compound annual growth rate remained 8.6%, my £1,000 would have more than doubled.
Nine years may sound like a long time, but I actually think it is very fast. Using the Bank of England base rate of 0.1%, doubling £1,000 by compounding interest would take 694 years. Of course, there’s less risk investing in a bank account rather than shares, whether or not they’re FTSE 100 shares. But there’s a 100% risk I’d be dead centuries before my 0.1% yielding investment doubled!
So, what about the specific risks when it comes to Imperial Brands? A key one is future smoking habits. In many countries, the number of smokers is in long-term decline. That could lead to falling revenues and profits, which would threaten Imperial’s ability to pay a dividend. Imperial is trying to fend off this risk. Its strategy is to build market share in five key sales territories as a way to mitigate falling market size. But doubling down on a declining format may be a short-term fix at best, setting up more problems for the future if cigarette volumes collapse altogether. As well as a risk to the dividend, the share price could also fall.
Why I’d buy this FTSE 100 share today
While Imperial Brands currently yields 8.6%, that will change if the share price moves.
But I would buy more Imperial Brands shares today for my portfolio, although I have shares in other companies, so my risk is reduced by some diversification.
