I’m searching for the best value stock in the FTSE 100 index. UK shares are cheap right now compared to many overseas stocks, so there’s an abundance of potential candidates.
One index constituent jumps out at me in particular. A bargain valuation combined with a mammoth dividend yield means this Footsie stalwart looks like a value investor’s dream, on paper.
I’m talking about British American Tobacco (LSE:BATS). Here’s my take on whether the company’s share price is in bargain basement territory today.
Valuing the stock
Using different valuation ratios, British American Tobacco shares look tempting. First, the forward price-to-earnings (P/E) ratio indicates how today’s share price measures up against projected earnings per share.
At just 7.9, BAT’s forward P/E’s considerably lower than the FTSE 100 average and, crucially, below that of key competitors like Imperial Brands, which trades for a multiple of 8.9.
The price-to-cash flow (P/CF) ratio under 7.2 is arguably even more impressive. Typically, any number below 10 indicates a stock that’s potentially undervalued.
British American Tobacco’s a highly cash-generative business. Over the last four years, the group’s delivered at least 100% operating cash conversion annually. This is good for liquidity and suggests the group’s using its working capital efficiently.
Dividend strength
Turning to dividend payments, the 8.2% yield’s eye-catching, to say the least. Few other dividend shares top this.
Forecast dividend cover of 1.5 times projected earnings looks reasonable. It’s below a ratio of two, which I’d ideally want to see. But it’s not so low that I have major concerns, albeit I’m conscious dividends are never guaranteed.
Nevertheless, I’m reassured by the payout history. Having raised shareholder distributions since 2000, British American Tobacco’s a member of the prestigious club of FTSE 100 Dividend Aristocrats.
The cherry on the cake is the resumption of a share buyback programme after repurchases were halted in 2023. In total, the business will buy back £1.6bn of shares this year and next, adding value for shareholders.
A sunset industry
Cautious investors might query why the stock looks so cheap. The central factor is the decline of the wider tobacco industry.
Cigarette consumption is falling rapidly. According to the World Health Organisation (WHO), only one in five adults worldwide use tobacco products today, compared to a third in 2000. Such a dramatic decline in the consumer base could be an existential threat to British American Tobacco’s long-term future.
Governments are keen to crack down on the industry. In the UK, the new government remains committed to Rishi Sunak’s generational smoking ban and anti-smoking measures are being considered for pub gardens too.
The bottom line
British American Tobacco has an answer to these challenges with reduced-risk products. It aims to become a smokeless business by 2035 and growth in this area has been promising. However, there’s a risk vapour products could also be caught by new government regulations.
I’m happy to own my existing British American Tobacco shares for the massive dividends. However, I haven’t bought more for a while now.
The stock’s certainly cheap, but is it truly the FTSE 100’s best-value stock? I think it would need to have a more robust source of future growth to credibly claim that title.
