Why looking at tobacco stocks makes me want to invest in Shell and BP shares

BP shares and those of fellow FTSE 100 oil stock Shell should have been destroyed by net zero, but tobacco stocks are showing the way forward.

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BP (LSE: BP) shares are flying right now, as is rival FTSE 100 oil major Shell (LSE: SHEL). Both are up more than 10% in the last month, boosted by the resurgent oil price, which is heading towards $100 a barrel. Measured over one year, they’re up 21.44% times 17.32%, respectively. 

BP and Shell have made a remarkable recovery since the pandemic sent the oil price down to around $20 and benefited from last year’s energy shock following Russia’s brutal invasion of Ukraine.

They’re no fossils

Where the oil price goes, their share prices tend to follow. With Saudi Arabia cutting production, and US political influence over the oil-rich Middle East kingdom not what it was, this trend could have much further to run.

This has come as a shock to those who thought the world was in the process of weaning itself off dirty old fossil fuels. Which brings me to tobacco stocks.

FTSE 100 cigarette makers British American Tobacco and Imperial Brands should in theory be terrible investments. They make products that literally kill people. In their millions. Users and investors know this, too. In the West, tens of millions have kicked the habit, and widespread bans on where people can light up have made smoking socially unacceptable.

The collapse in smoking across the developed world should have finished off big tobacco, but even non-smokers invest in the sector. Manufacturers still make heaps of money, first, because tobacco is highly addictive, and second, because they’ve adopted clever strategies to take a greater share of a declining market.

Now they’re pioneering new categories of tobacco, such as vaping and e-cigarettes, and making billions despite controversies. Their share prices may be floundering but they’re still brilliant income investments with yields to die for. British American Tobacco pays income of 8.5% with Imperial Brands close behind at 8.14%.

Which brings me back to BP and Shell. Arguably, they also make products that kill people, say, through motor accidents and pollution. Oil and gas are also highly addictive, the fuel that drives our prosperity. Despite endless campaigns by green activists, the habit is hard to kick.

We can’t kick oil and gas

Clean alternatives such as wind and solar are getting cheaper but with the world consuming almost 100m barrels of oil every single day (I can’t even picture that), there’s a long, long way to go.

Investors are waking up to this and realising that BP and Shell may prove to be good long-term investments after all. Like big tobacco, big oil can deliver juicy dividends in a declining market, arguably for decades.

Today BP and Shell yield 4.09% and 3.61%, respectively, which is less than before. Yet these numbers are likely to climb over time, especially if their share prices retreat at some point, which is more than possible after such a strong run.

Both are still cheap, trading at 6.34 and 7.82 times earnings, respectively. As are British American Tobacco and Imperial Brands, valued at 6.97% and 9.89%.

I don’t know where the BP and Shell share prices will go in the short run, but I know that in the longer term, there are good reasons why those dividends will keep rolling in for decades. Both are on my buy list but I marginally prefer BP for its lower valuation and higher yield.

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.

Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco P.l.c. and 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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