With a dividend yield of 6.4%, is this cheap FTSE 100 stock a buy for me?

This FTSE 100 stock might have a strong dividend yield, but is that enough reason to buy it?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

On average, the FTSE 100‘s dividend yield, is 3.2% right now. So, it follows that any of the index’s constituent stocks with a higher yield would be more desirable to the income investor, yes? Maybe, maybe not. In my opinion that would be so only if the dividend is sustainable and the stock’s price is not falling fast. If the latter is the case, I may make no net gains or worse, end up with a net loss on the investment. 

British American Tobacco’s strengths

It is from this perspective that I am now considering whether or not to buy the tobacco stock British American Tobacco (LSE: BATS). It has a dividend yield of 6.4%, which is far above the FTSE 100 average. It is also above the inflation rate, which is pretty high at 5% right now. This in itself makes the stock worth considering. 

Is it sustainable, though? Well, I have no reason to doubt it considering that the company has consistently paid dividends over the years. And going by its outlook for 2022, it is quite likely to continue paying them in the future too. I am basing this on the fact that it expects earnings per share to grow. It also mentions “maintaining growing dividends” elsewhere in its latest update.  

Competitive price for the FTSE 100 stock

The next question is, what is the outlook for its share price? The British American Tobacco share price is up some 22% in the past year, which sounds positive. As per its latest results for 2021, its earnings are up from the year before. Also, as I mentioned earlier, it expects them to grow next year too. This could continue to push its share price up, particularly because its market valuation is still cheap. It has a price-to-earnings (P/E) ratio of around 11.7 times, which is lower than that for the FTSE 100 at around 18 times.

The long-term challenge

The one big challenge with tobacco stocks, though, is the long-term future. As the company itself points out in its update, global tobacco industry growth is expected to decline by 2.5% in 2022. It expects its own revenue and earnings to grow, but it is hard not to consider how long it can grow in a shrinking industry. Its tobacco alternatives’ division, called new categories, is growing fast, to be sure. But it is still quite small. Even with a 50%+ growth last year, it is less than 10% of the company’s total revenue. At this rate, it might be decades before this market matures, in my view. And what becomes of British American Tobacco in the interim? I am not sure. 

My assessment

Perhaps it is for this reason that the FTSE 100 stock has seen quite a steep decline in share price over the past few years. It is down over 30% in the past five years. Also, it compares unfavourably to its FTSE 100 peer Imperial Brands, which trades at a multiple of sub-6 times. And also has a higher dividend yield of 7.8%. Between the two tobacco stocks, I would much prefer it to British American Tobacco and that is why I bought it. Though I am keeping an look out for further developments in the latter, I am not buying it yet. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Manika Premsingh owns Imperial Brands. The Motley Fool UK has recommended British American Tobacco and Imperial Brands. 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.

More on Investing Articles

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

Here’s Buffett’s ‘secret sauce’ to finding the best UK shares to buy today

Zaven Boyrazian explores the secrets behind Warren Buffett’s investing strategy that led him to discover incredible marketing-beating stocks.

Read more »

Passive income text with pin graph chart on business table
Investing Articles

How to start earning passive income for life with just £3.40 a day

Dividends can be a tremendous and lucrative source of passive income, even when only investing a tiny sum each day.…

Read more »

Investing Articles

2 bargain FTSE 100 shares with dividend yields above 9%!

These FTSE 100 stocks look cheap, based on predicted earnings and dividends. Here's why I think they could be great…

Read more »

Fireworks display in the shape of willow at Newcastle, Co. Down , Northern Ireland at Halloween.
Investing Articles

2 top growth shares I’d buy for the second half of 2024!

Looking for the best growth shares to buy? These FTSE 250 and small-cap shares have significant share price potential, according…

Read more »

Investing For Beginners

How to try and build a £250k Stocks and Shares ISA from scratch, starting in 2024

With a regular savings plan and a smart investment strategy, it’s possible to build wealth within a Stocks and Shares…

Read more »

Investing Articles

I’m considering 3 top UK dividend stocks for my portfolio this July

Mark David Hartley is looking at adding a few dividend stocks to his portfolio this month. Will these three shares…

Read more »

Investing Articles

3 FTSE 100 shares I’d buy to create lasting passive income

Dividend stocks are a great way to build an additional income. Our writer details three FTSE 100 picks she’d love…

Read more »

Investing Articles

After falling 9% in 6 weeks, is this FTSE 100 stock now in bargain territory?

The BAE Systems share price hit a 52-week high on 3 June. Six weeks later, it’s down nearly 10%. Is…

Read more »