The FTSE 100’s British American Tobacco (LSE: BATS) looks like a classic ‘unloved-cash‑machine-trading-at-a-discount’ story to me.
The valuation gap to ‘fair value’ is still anchored in concerns about regulatory pressure and the long path away from combustible products.
Both elements do remain risks for the firm, of course. But it is also remains a mighty dividend powerhouse, with no sign of this ending. Its cash generation is formidable and is underpinned by strong earnings growth forecasts.
So how much dividend income could I make from my £20,000 holding in the firm?
Rising dividends forecast?
In 2025, it paid a dividend of 240.24p, giving a yield of 5.5% on the current £43.58 price. This is much higher than the present FTSE 100 average of 3.1%. It also sits above the 4.5% ‘risk-free rate’ (the 10-year UK gilt). This effectively provides compensation for taking the extra risk of investing in shares over no risk at all.
However, analysts expect the dividend to increase to 250.9p this year, 259.2p next year, and 286.3p in 2028. These would generate respective yields of 5.8%, 5.9%, and 6.7%.
This rising trend aligns with that of recent years, with dividends increasing from 210.4p in 2020 to last year’s 240.24p. These provided respective annual average yields from 2020 of 7.8%, 7.9%, 6.7%, 10.1%, and 8.2%.
How much dividend income can I make?
My £20,000 holding would make £19,012 in dividends after 10 years and £128,434 after 30 years. This assumes a forecast 6.7% dividend yield across the period, although it could go down too. It also factors in the payouts being reinvested back into the stock to utilise the turbocharging effect of dividend compounding.
The 30-year period is widely seen as the standard investment cycle for long-term investors. It covers first investments around 20 to early retirement options around 50.
After 30 years, the value of my holding could be £148,434 (including the original £20,000 investment). And this could pay me £9,945 a year in dividend income.
Share price gains too?
Every share I buy for its dividend income potential is also undervalued at the time too. This is because I would like to make money from the price-to-valuation gap if I ever need to sell it.
The gap reflects the fact that price is whatever the market will pay at any point, but value reflects the underlying business’s fundamentals. Knowing this is crucial to long-term investors’ profits, as asset prices tend to trade to the true value over time.
How much could be made in the gap here?
In my experience as a former investment bank trader, discounted cash flow (DCF) analysis is the best way to ascertain a share’s true worth. It estimates a company’s fair value by projecting its future cash flows and then discounting them back to today. Some analysts’ DCF modelling is more bearish than mine, and some more bullish, depending on the inputs used.
However, based on my DCF assumptions — including an 8.5% discount rate — British American Tobacco shares are 38% undervalued at their current £43.58 price. Therefore, their fair value could secretly be close to £70.29.
Given its strong earnings growth forecasts that should support ongoing high dividends and share price gains, I will buy more of the stock very soon.
