Investing in shares to create a second income from dividends has never been easier than today. And if I do this inside a Stocks and Shares ISA, I don’t have to worry about paying tax on my returns.
Even better for UK investors, the London Stock Exchange is packed with ultra-high-yield dividend shares right now. That’s because a lot of share prices have been under pressure due to higher interest rates, and this has pushed yields up.
A notable example is British American Tobacco (LSE: BATS). The share price has fallen around 18% over the past year, meaning the forecast dividend yield for 2024 is a massive 10.1%.
If I had £10k sitting idle in an ISA today, I’d consider this FTSE 100 tobacco stock for passive income.
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Portfolio choices
Now, while I recently invested in the share, I had my reservations. As The Motley Fool co-founder David Gardner often says: “Make your portfolio reflect your best vision for our future.”
Is smoking really my best vision for that future? I mean, even British American Tobacco itself is officially committed to “building a smokeless world“. But isn’t that a bit like KFC moving away from chickens?
There does seem obvious above-average risk here, and that worried me.
Of course, it’s for each person to decide how they invest. Some investors won’t put their money in oil or defence stocks. Others wouldn’t touch gambling stocks with a 10-foot barge pole. And that’s fine.
So why have I chosen to invest?
Three reasons
Firstly, the stock appears to offer incredible value trading at just 6.3 times forecast earnings.
Granted, there are risks to earnings associated with the long-term decline in smokers globally. But I can’t help feeling that this is priced into the valuation (and then some). There looks to be a margin of safety.
For context, Philip Morris International stock is trading at 15.2 times forecast earnings while carrying a 5.7% dividend yield.
If British American Tobacco ever decides to move its main listing to New York, I reckon the shares would re-rate significantly in anticipation of a higher potential valuation. We’ve seen such examples in recent times, and in a sense it’s almost self-fulfilling.
Second, the high-yield dividend appears sustainable. The payout for FY 2024 is covered 1.53 times by anticipated earnings. In other words, the forecast dividend per share (238p) is covered by forecast earnings per share (365p).
So, while no dividend is ever guaranteed, this one looks likely to be paid out.
Lastly, the company’s New Categories division, which houses vaping brands like Vuse, turned profitable in 2023. That was two years ahead of the firm’s original target, which is a positive sign for the future.
Passive income
As mentioned, each share is forecast to pay out a dividend of 238p for this financial year. In 2025, brokers see that rising to 248p per share.
Of course, analysts’ expectations don’t always come to fruition. And one quarterly payout has already been arranged (due to be paid on 2 May).
But assuming these forecasts prove correct, this means £10k worth of shares bought today could pay out around £1,800 in passive income over the next couple of years.
Then potentially more in the years after, depending on business performance.
