Investors don’t buy British American Tobacco (LSE: BATS) shares expecting capital growth. Mostly they’re after the dividend income and there’s nothing wrong with that.
Who cares if the company’s share price is consistently heading south, provided investors can bag a yield of 7% or 8% a year along the way? That’s the argument in favour of buying the cigarette giant’s shares, crudely put.
Right now, the shares actually deliver an incredibly attractive yield of 9.38% a year, one of the most spectacular on the entire FTSE 100.
It’s all about the income
Markets predict this will increase to 10.3% in 2023 and 10.5% in 2024. With interest rates, bond yields and cash savings all likely to fall next year, that looks like an unmissable rate of income. An average yield of 10% would double my money in less than eight years, even if the share price does not rise at all in that time.
Yet there’s a problem with this argument. One of the big attraction of a high dividend is reinvesting it back into the stock, which helps turbocharge overall performance. The sums don’t work half as well if the share price is consistently falling, though. And that’s what’s been happening to British American Tobacco.
Its shares have crashed – yes that’s the right word – 30.33% over the last year, one of the biggest losses on the entire FTSE 100. Only Fresnillo, St James’s Place and Anglo American have fared worse.
If I’d invested £10,000 in British American Tobacco 12 months ago, when it traded at 3,314p, I’d have picked up around 301 shares. Today, with the stock trading at 2,320p, those same shares would be worth just £6,983.
However, I’d also have received that famous dividend. Based on the full-year 2022 dividend of 217.8p per share, my 301 shares would have given me income of £656.
That would pare my losses but I’d still have just £7,639. That’s a paper loss of £2,361. My dividend income will have been dwarfed by the capital loss.
Of course, every share price has its ups and downs. This can actually benefit dividend shares, especially during the wealth building stage, as reinvested dividends will pick up more stock at the lower price. Yet if the stock has reduced growth potential, the sums don’t work half as well.
Better dividend opportunities
British American Tobacco is not necessarily destined to carry on falling. It’s been struggling for years, but is dirt cheap, trading at just 6.22 times earnings. That offers a cushion against further share price falls, and may attract buyers.
Tobacco is a dying industry, in more ways than one, but British American Tobacco can profit by taking a large share of a shrinking sector. It has boosted its volume share leadership through the power of its five global brands Dunhill, Kent, Lucky Strike, Pall Mall and Rothmans.
It also throws off plenty of cash – even in a downturn – because its customers are literally addicted to what it sells. And it isn’t afraid to court controversy by assertively targeting new customers through vaping and e-cigarettes.
Personally, I don’t buy tobacco stocks, but even if I did, I’d avoid British American Tobacco. I love a high dividend, but I like the opportunity for a bit of share price growth too. Plenty of other FTSE 100 stocks give me a shot at both.
