When choosing income shares for my portfolio, a high dividend yield might seem tempting to me. But whether I buy depends on what I think a company’s long-term prospects might be. After all, dividends are never guaranteed. Tobacco company Imperial Brands (LSE: IMB) has a dividend yield of 8.6%. So a £1,000 investment in Imperial Brands shares today would hopefully earn me £86 annually in dividends.
But does it make sense for me to buy the shares for my portfolio?
Plays and players
When considering whether to buy shares, one thing I do is consider the long-term economics of an industry. If I think they could be good, I then try to understand what companies within that industry look strongly positioned to me.
As an industry, I think tobacco has big problems ahead. The number of cigarette smokers is in long-term structural decline. Smoking is increasingly regulated in many markets. Lawsuits continue to cost the industry vast sums annually and I expect that to continue.
On the other hand, cigarettes alone remain huge business. Newer products like vapes could help nicotine product sales grow for decades and existing tobacco companies look well-placed to benefit from that. Tobacco is a highly cash generative business, supporting juicy dividends at Imperial and rivals. The industry has been battling big problems for decades already and continues to throw off a lot of cash.
Imperial Brands or British American?
However, are Imperial Brands shares the most attractive investment for me to get exposure to tobacco on the London stock market?
The company does have well-known brands including Lambert & Butler and Rizla. Its current price-to-earnings (P/E) ratio of six looks like a cheap valuation.
But I am concerned that Imperial is less well-positioned for a declining cigarette market than rivals investing more in non-cigarette products. Imperial’s rival British American Tobacco (LSE: BATS), for example, has been aggressively growing its non-cigarette business. Imperial’s approach has been more conservative.
British American’s P/E ratio of seven is only slightly more costly than Imperial’s. The yield, at 8.7%, is a little higher. Whereas Imperial slashed its dividend in 2020, British American has raised its payout annually for over 20 years.
Meanwhile, I see British American as having stronger growth potential than Imperial, due to its larger global business and strong push into non-cigarette products. Last year, its revenues grew 8%, while earnings per share slipped 1%. Imperial saw revenues fall 1% and earnings per share decline 45%.
One year’s results are just a snapshot. But I see British American as a business that has the wind in its sails more than Imperial, at an almost equally attractive valuation.
Choosing one option
Given what I see as the long-term potential of the tobacco industry despite significant risks, I am happy to own a UK tobacco share in my portfolio.
For now, I see investing in British American Tobacco as offering me more attractive long-term prospects than buying Imperial Brands shares. That is why I own no Imperial shares, but have increased my British American holding this year.
