I’d buy 1,039 shares of this stock to generate £200 extra income per month

Christopher Ruane explains how he’s already earning extra income by owning a blue-chip FTSE 100 dividend share — and would happily buy more today.

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A bit of extra income can often come in handy.

My own approach to that includes buying blue-chip FTSE 100 shares I hope can pay me dividends in future.

Here is an example of how buying 1,039 shares in one such business today could hopefully generate me £200 per month on average in extra income, hopefully for decades to come.

Industry with large free cash flows

As the latest dividend hike from Imperial Brands today (14 November) demonstrated yet again, tobacco is an industry with favourable economics.

Cigarettes are cheap to make, but the set-up costs for a factory act as a barrier to entry for casual competitors. Customers buy regularly and are willing to pay a high price premium over the manufacturing costs.

But Imperial is not the company I would choose for my extra income plan.

Instead, I am eyeing a larger FTSE 100 cigarette maker with a higher dividend yield — 9% versus Imperial’s 8%. It also has a better track record of dividend growth in recent years. Indeed, it has raised its payout every year this century so far.

British champion

The share in question is British American Tobacco (LSE: BATS).

Headquartered by the Thames, it operates in many markets globally. It is one of the world’s leading tobacco companies and owns premium brands including Lucky Strike, Rothmans and (in the US) Camel. That gives the business pricing power.

A quick look at its financial statements brings the point home.

Revenues last year grew 8% to £27.6bn. In a way, that sales growth is surprising. After all, perhaps the biggest threat to the company’s sales and profits is declining cigarette use in many markets. But the firm’s pricing power means it can push up selling prices to help offset falls in volume.

Meanwhile, post-tax profit was a whopping £6.9bn.

At a net profit margin of 24.8%, that underlines just how attractive the economics of the tobacco business remain.

Indeed, profits have actually been dragged down by losses in the company’s non-cigarette division. But they are expected to end this year and I think the division could help British American Tobacco keep growing in future.

Huge dividend payer

All of that adds up to financial firepower that lets the company pay a sizeable dividend. That provides extra income for thousands of shareholders, big and small, on a regular basis.

Tobacco companies often see their dividends as an important way to attract investors given their apparently limited growth prospects, although I think British American’s track record of growth suggests otherwise.

In any case, each share currently pays an annual dividend of around £2.31. That means if I bought 1,039 shares today, I ought to earn £2,400 in annual dividends. That is around £200 a month on average, although in practice dividends are paid quarterly.

The company has said it plans to keep raising the payout annually, although its high debt is a risk to free cash flows.

I already own British American shares and want to stay suitably diversified. But if I had spare cash today and could keep my portfolio sufficiently diversified, I would be happy to buy more of the shares for some extra 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.

C Ruane has positions in British American Tobacco P.l.c. 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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