With an 8.4% dividend yield, are Imperial Brands shares a buy?

Imperial Brands shares pay one of the highest dividend yields in the market, but are they worth buying at the current price? Gordon Best takes a look.

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There are plenty of companies paying a dividend in the current market. But when I see a yield over 8% I really pay attention. Although not always a sign of a good investment, high dividend yields can be a great way to grow passive income. Imperial Brands (LSE:IMB) shares pay a very appealing 8.4% dividend yield, but is this a company worth investing in?

What does it do?

Imperial Brands is a British multinational tobacco company headquartered in Bristol. It’s one of the world’s largest tobacco companies, with brands such as Davidoff, Gauloises, JPS and Winston.

The shares have been on a downtrend in recent years as the company has faced increasing scrutiny from regulators and consumers due to the health risks associated with tobacco products. However, its stock has recently started to rebound.

What do I need to know?

There are a few things to consider before making a decision to buy. First, it’s important to understand the risks mentioned above. The tobacco industry is facing a number of challenges, including declining smoking rates, increasing regulation, and rising litigation costs. These challenges could put pressure on profits in the future.

Second, with an investment of this nature, it’s important to consider my own investment goals. Imperial Brands could be a good option as a dividend stock, providing a steady stream of income. The dividend is expected to grow even further to 9.1% in coming years, indicating confidence. However, I’m looking for shares that have potential to grow in value over the long term. With revenues and profit margins expected to decline in the years ahead, I believe Imperial Brands shares will likely underperform the wider market.

Are the shares undervalued?

It’s important to consider the valuation of this stock. The company’s shares are currently trading at a forward price-to-earnings (P/E) ratio of 10. This is below the average P/E ratio for the FTSE 100. It’s also below the P/E ratios of some of the firm’s peers, such as Philip Morris International. A discounted cash flow calculation suggests the shares may be undervalued by at least 58%. This indicates that an investment may have considerable potential if its risks can be mitigated.

An interesting metric for Imperial Brands is return on equity (ROE), which shows how efficiently management is able to generate profit from investment. Compared to the industry average of 15%, the company’s 29% looks very impressive. However, with over £10bn of debt, this figure is somewhat less useful. Short-term debts are also not well covered by the company’s assets, which could spark investor concerns, despite the long-term debt situation appearing more sustainable.

Am I buying?

Imperial Brands shares do offer an attractive dividend yield to investors. However, with expected growth in the company likely to be below the market, I fear that poor performance in the share price may offset this generous dividend.

The tobacco industry is rightly facing a number of challenges with the modern, more health-conscious consumer. This could put pressure on Imperial Brands prospects. Despite the shares currently trading at a below-average P/E ratio, and having plenty of potential to grow further, I want to put my money to work elsewhere.

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.

Gordon Best has no position in any of the shares mentioned. The Motley Fool UK has recommended Imperial Brands Plc. 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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