FTSE 100 tobacco and nicotine replacement products giant Imperial Brands (LSE: IMB) paid a 2023 dividend of 146.82p. This gives a yield on the current £20.43 share price of 7.2%.
This is double the FTSE 100’s average yield of 3.6%, and more than twice the FTSE 250’s 3.3%.
If I invested £17,000 (the average UK savings account amount) in the shares, I would make £1,224 this year. If I withdrew that money and spent it, I would have the same return next year, provided no change in the yield. Over 10 years on the same basis, I would have an extra £12,240.
However, if I bought more of the shares with the dividends it paid me (‘dividend compounding’) I would make much more.
In this case, after 10 years I would have an additional £17,850 rather than £12,240. This would give me a total pot worth £34,850.
Over 30 years on the same average yield, its value would have risen to £146,461.It would pay me £10,545 a year in dividends, or £879 every month!
What is the dividend yield outlook?
Yields rise and fall on changing share prices and dividend payments. Over time though, both are likely to rise if a company’s earnings consistently increase.
One risk in Imperial Brands is any delay in its transition from tobacco products to nicotine ones. This might allow its competitors to gain a market advantage. Another is any legal action arising from the use of its tobacco products in the past.
However, its H1 adjusted operating profit rose by 2.8% year on year. Also positive was net revenue growth of 16.8% for its next-generation nicotine substitute products.
This followed its full-year 2023 results showing operating profit up 26.8% from 2022 to £3.4bn.
From here, consensus analysts’ estimates are that its earnings per share will rise by 5.9% a year to end-2026. Return on equity is forecast to be 47.9% by that point.
Forecasts are also for dividend payments to rise to 153.2p a share this year, 160.5p in 2025, and 169.6p in 2026. On the current £20.43 share price, this would give respective yields of 7.5%, 7.9% and 8.3%.
Is it undervalued?
Imperial Brands shares trade on the key price-to-earnings (P/E) stock valuation measure at just 8.3. This looks very cheap compared to its peer group average of 15.1.
The same is true on the price-to-sales metric, with the firm trading at only 1, against a 3.2 peer group average.
A discounted cash flow analysis shows it to be 61% undervalued at its current price of £20.43. So a fair value would be around £52.38, although there is no guarantee they will reach that level.
Its high yield, extreme undervaluation, and strong business prospects make it an unmissable passive income opportunity for me. Consequently, I will be adding to my holding in the stock at the earliest opportunity.
