This FTSE 100 stock pays out £2.31 per share in dividends. Time to buy?

Ben McPoland takes a look at the stock with the highest FTSE 100 dividend yield and wonders whether investing in it is worth the risk.

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In March, Vodafone cut its dividend in half. This has left British American Tobacco (LSE: BATS) shares carrying the highest dividend yield in the FTSE 100.

Each share offers a dividend of £2.31, which translates into a massive 9.9% yield.

And while Vodafone proved that a ultra-high yield is often a red flag, British American Tobacco seems to be a rare exception. In fact, I reckon eyebrows would be raised if this firm’s payout was slashed by 50%.

But should I buy this tobacco stock for my portfolio? Let’s discuss.

The case against

The company owns cigarette labels such as Camel and Lucky Strike, as well as smokeless brands Vuse (e-cigarettes), Velo (pouches), and Glo (heated tobacco).

These helped bring in roughly £27.3bn in revenue in 2023. However, 81% of that came from cigarettes, and smoking has been in decline for yonks, as we all know.

Indeed, declining smoking rates resulted in a £27.3bn write-down in the value of some of its American combustible brands last year. And this non-cash impairment charge resulted in a £15.7bn loss from operations.

Additionally, its alternative products, notably vaping, are coming under increasing regulatory pressure. Some countries have already banned them and more could follow.

Will vaping replace cigarettes and have the same high profit margins? Or will that industry also eventually go up in a puff of smoke? This uncertainty is why the share price has fallen 24% in five years.

The case for

We will work to Build a Smokeless World. The way we will do this is by switching as many smokers as we can to our smokeless products.

British American Tobacco

On the other hand, these are not exactly new concerns. And the massive yield is the reward for taking on these risks.

I have to admit the forecast dividends here do look enticing.

Financial yearDividend per shareDividend yield
2025 (forecast)248p10.5%
2024 (forecast)238p10.1%

Of course, no dividend is absolutely guaranteed. But the payout ratio was 63% of earnings last year, which suggests the dividend’s sustainable.

Moreover, it plans to buyback £1.6bn worth of its shares after selling a portion of its stake in Indian consumer-products company ITC. It will buy back £700m worth in 2024 then use the remaining £900m in 2025.

ITC dominates the Indian cigarette market, and British American’s investment in it is still worth roughly $15bn. Not a bad asset to have in the back pocket if need be!

Finally, its New Categories division achieved profitability for the first time last year — a full two years ahead of schedule That’s also a positive sign for the future.

My verdict

In the 1980s, Warren Buffett said: “I’ll tell you why I like the cigarette business. It costs a penny to make. Sell it for a dollar. It’s addictive.”

Today, the company still possesses pricing power and remains a cash machine. However, due to falling tobacco sales, the stock now trades at a bargain-basement valuation.

We’re looking at a forward price-to-earnings (P/E) of 6.4, with a forecast dividend yield of 10.1%. For context, in mid-2013, the shares were trading on a forward P/E of 15, with a prospective yield of 4.3%.

To me, this high-yield FTSE 100 dividend stock offers exceptional value. So much so, I’ll embrace the risks and add it to my income portfolio.

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.

Ben McPoland has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco P.l.c. and Vodafone Group Public. 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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