Am I too late to act on the soaring BATS share price?

The BATS share price has surged more than 20% in under two months. Our writer considers whether he should add more of the stock to his portfolio.

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Things have been looking up lately for shareholders in British American Tobacco (LSE: BATS). The BATS share price has jumped 21% since the start of last month, at the time of writing this article earlier today. Over the past year, though, the gain has been a more modest 13%.

After shares in the company moved up sharply in a matter of weeks, am I now too late to buy more for my portfolio?

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Price increase drivers

A number of factors help explain the recent upward movement. In October, the US regulator the Food and Drug Administration (FDA) cleared BATS to market a line of e-cigarettes. That was the first time the FDA had given clearance to a vaping product. BATS has pinned a lot of hope on growing sales of non-cigarette products such as its vaping line. So the FDA approval was seen as positive for future revenues.

There has also recently been a move by many investors into more defensive stocks, such as tobacco. Indeed, the London company’s performance in the past year has been less impressive than that of US rival Philip Morris International. Its New York-listed shares have added 26% in the same period, twice the gain seen at BATS.

Is the BATS share price still cheap?

Even after the upward move, I still reckon BATS could climb higher. Compared to its historical price, it looks cheap to me. The shares are 34% below where they stood five years ago. The price-to-earnings ratio is around nine, which seems cheap. The dividend yield is 6.9%. Although that is lower than a few months ago due to the increased share price, it is still well above that of most FTSE 100 shares.

Last week, Barclays raised its target price on BATS. The bank said that the share looks cheap relative to its future earning potential. The bank also highlighted the fact that BATS reckons it can break even on its next generation products in 2025. If the company manages to hit that target, it would end the initial stage of developing a next gen portfolio. So far, the company has focused on growing revenues not aiming for profits. Moving into profit on sizeable, growing next gen revenues could help the company’s economics even in the face of declining cigarette demand in many markets. That could support a higher share price in future.

So far, though, it is not clear if next gen products will ever match the profit margins offered by cigarettes. So there is a risk that, even if the company can sustain its revenues over the long-term, profitability may fall. That could lead to a falling share price down the line as cigarette revenues and profits decline.

My next move

I already hold a sizeable BATS position. But despite that I would consider buying more of the company’s shares. Even though the share price increase means buying now offers me a lower yield than a few months ago, I still regard the company as attractive for its passive income potential.

On top of that, if the shares keep moving up, I may also be able to benefit from capital gains. I see that as plausible given the company’s relatively cheap valuation in recent years. Even after recent gains, I continue to see strong arguments to add more BATS shares to my portfolio.

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Christopher Ruane owns shares in British American Tobacco. The Motley Fool UK has recommended Barclays and British American Tobacco. 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.

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