8.7% yield! Is this dividend stock a brilliant bargain or an investor trap?

Imperial Brands shares offer one of the biggest forward dividend yields on the FTSE 100. Is now the time to buy this dividend stock?

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The UK stock market has experienced extreme choppiness in 2023. Concerns over rising interest rates and their impact on the already-sluggish global economy have caused even high-quality companies to slump in value.

Tobacco companies like Imperial Brands (LSE:IMB) have traditionally been popular in tough times like these. Yet this defensive FTSE 100 stock has lost 16% of its value in the year to date. As someone who’s looking to buy cheap dividend stocks this has really attracted my attention.

The dividend yield on Imperial Brands has risen to a whopping 8.7% for the current financial year (to September 2024). So should I buy the tobacco titan for my portfolio today? Or does it offer too much risk to investors like me?

Good news

The Imperial Brands share price has been on a rollercoaster ride this month. After slumping to 17-month lows, the firm has roared back following the release of half-year financials.

In that update the John Player Special, Winston and West manufacturer announced that sales rose by low single digits in the 12 months to September. It added that adjusted operating profit rose “to the lower end of our mid-single-digit range.” The company was helped by aggregate market share gains across its top five markets.

Investors also liked Imperial Brands’ decision to repurchase £1.1bn of its shares in the new financial year. That’s up from £1bn in financial 2023.

Tobacco companies have long delivered lots of cash to shareholders through share buybacks and big dividends. This is thanks to their strong profits and cash flows, which remain broadly stable at all points of the economic cycle.

In terms of dividends, City analysts are expecting the firm to raise its already big dividends again in the current year. So the business carries that mighty 8%+ forward dividend yield.

Bad news

This, along with Imperial Brands’ low forward price-to-earnings (P/E) ratio of 5.7 times, may make the company look like an exceptional bargain. I’m not so sure, however. Its market share might be rising, but the broader tobacco market is facing extinction, which poses obvious long-term danger.

It’s not just cigars and cigarettes that are in peril, of course. New technologies like heated tobacco products and vaporisers are also in the crosshairs of legislators seeking to clamp down on how they’re sold, marketed and used.

British prime minister Rishi Sunak’s declaration to steadily raise the legal age for buying cigarettes in England sent Imperial Brands’ share price crashing last week. Both the Conservatives and Labour have also threatened to slap restrictions on the vaping segment, with the opposition promising to come down on it like “a tonne of bricks.”

My verdict on the shares

This ’war on tobacco’ is picking up speed all over the globe. And it poses clear risks to tobacco companies and their shareholders.

Imperial Brands said this month that it had witnessed “relatively higher volume declines against historic averages” between April and September. And the problem isn’t going away, which is why the company carries such a low valuation.

On balance I’d rather buy other cheap stocks for passive income.

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.

Royston Wild 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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