Rarely do investors get an opportunity to buy income stocks in the FTSE 100 with yields close to 10%.
But here are two — British American Tobacco (LSE:BATS) and Vodafone (LSE:VOD) — that are currently yielding 8.9% and 9.8%. However, both stocks are not far off their 12-month lows.
The maths
Of course it’s no coincidence that they’re presently offering a generous yield. This is calculated by dividing the expected annual dividend by today’s share price. If the latter is falling but the payout to shareholders remains the same, the yield will go up.
Neither company is expected to cut its dividend this year. Vodafone’s has remained unchanged for the past five financial years. In contrast, BAT has a history of increasing its payout annually. The last time it was reduced was in 2018.
However, a falling share price could be a warning sign that something’s wrong. Should I ignore this in the hope of achieving a near double-digit return?
Going up in smoke
The decline in BAT’s stock probably reflects concerns that governments in key markets are starting to restrict the sale and promotion of so-called reduced-risk products (RRPs). The success of these products is essential if the company’s transition away from traditional tobacco is to be sustainable.
RRPs are expected to be profitable in 2024. And they’re forecast to generate £5bn of revenue in 2025 (2022: £2.9bn).
But cigarette sales in the US are showing signs of slowing.
The company also has huge borrowings. At 31 December 2022, its net debt was nearly three times’ earnings.
Despite this it remains on course to meet its full-year profit guidance.
And it remains hugely cash generative. Last year its operating activities produced £10.3bn of cash. The dividend cost £4.9bn, so I don’t see any immediate threat to the current payout.
But I think tobacco stocks are in long-term decline. I don’t see these new products being able to replace their traditional ones to the same extent. For this reason, I’m not going to invest.
Ringing the changes
The steady decline in Vodafone’s share price probably reflects its lack of growth. Revenue for its 2023 financial year was only 4.6% higher than in 2018.
And, a bit like BAT, the company’s borrowings are on the high side.
However, the company’s new chief executive has acknowledged the need to implement change. As part of this strategy, she has embarked on a massive cost-cutting exercise. The group has become bloated and less able to respond quickly to market changes.
The company’s biggest shareholder, e&, now has a seat on the board. I think this is important as it could lead to a more formal partnership in the Middle East and Africa.
One merger that’s rumoured to be announced soon is between Vodafone’s UK operations and Three.
In my view, these changes are likely to boost the company’s shares. At the same time, they will ensure that the dividend is maintained at its current level.
I already own shares in Vodafone. But if I didn’t, I’d buy some.
A final thought
My analysis suggests that a high-yield/low share price combination is either a sign that the company is not fulfilling its potential (Vodafone), or an indication that there are concerns about its future profitability (BAT).
Either way, I always think it’s worth investigating further.
