FTSE 100 tobacco and nicotine replacement products manufacturer British American Tobacco (LSE: BATS) is overlooked by many on ethical grounds.
As a former heavy smoker myself, I understand this. But I am not ignoring the stock. Rather, I have used it to recoup some of the vast amount of money I spent on cigarettes over 35 years
Big dividends
In 2022, the company paid 217.8p a share in dividends. Before that it paid 215.6p in 2021, 210.4p in 2020, and 203p in 2019. These yielded 6.7%, 7.9%, 7.8% and 6.5%, respectively.
Last year, it paid 230.89p. With the shares at £24.64, this made the yield 9.4% — one of the highest in the FTSE 100.
And analysts forecast that the yields will rise to 9.6% in 2024, 10% in 2025, and 10.5% in 2026.
Huge passive income streams
Passive income is money made from minimal effort, such as dividends from shares. Unlike when I smoked, my pleasure from these regular payments is not accompanied by a hacking cough!
So, £17,000 (the average UK savings account amount) would buy 690 shares in British American Tobacco.
These would pay £1,598 in dividends in the first year, based on the current 9.4% yield.
The same amount would be paid yearly if the dividend stayed the same and I withdrew the payments as cash. So, after 10 years, an extra £15,980 would have been made, and after 30 years an additional £47,940.
However, the returns would dramatically increase if the dividends were used to buy more of the shares (known as ‘dividend compounding’).
An extra £26,361 would be made instead of £15,980 after 10 years by doing this. After 30 years, an additional £265,090 would have accrued instead of £47,940.
The total British American Tobacco investment would be worth £282,090 by then. It would generate £26,516 every year in passive income, or £2,210 each month!
Share price undervaluation
Making spectacular returns is no use if they are then wiped out by share price losses, of course. Consequently, I always look for high-yield stocks that are also undervalued against their peers. That way, there is less chance of big price falls happening over the long term.
A risk in the shares is that its competitors are more successful in transitioning to nicotine substitute products. There also remains a threat of legal action from former smokers for alleged damage done to their health.
However, analyst forecasts are that the firm’s earnings will increase by a whopping 51.7% a year to the end of 2026.
Moreover, a discounted cash flow analysis shows the stock to be 53% undervalued at its present price of £24.64. So, a fair value per share would be £52.43, although they may go lower or higher than that.
If I did not already own the shares, I would buy them today for their very high yield and extreme relative undervaluation.
