Passive income is money generated with little ongoing effort, most notably in my view through share dividends. Such income can be incredibly powerful for investors, helping to smooth market volatility, compound returns, and build long‑term financial resilience.
One company that stands out as a potential cornerstone for passive-income seekers is British American Tobacco (LSE: BATS), but why?
Consistently high yields
Its appeal starts with a dividend yield that sits well above the FTSE 100 average. From 2020 to 2024 alone, it paid respective dividends of 210.4p, 215.6p, 217.8p, 230.89p, and 235.52p. These generated respective annual average yields of 7.8%, 7.9%, 6.7%, 10.1%, and 8.2% in those years.
Its current dividend yield is 5.5%, but returns can go down as well as up over time.
In fact, analysts forecast British American Tobacco’s dividends will rise to 251.4p this year, 259.8p next year, and 272.2p in 2028. These would generate respective yields of 5.8%, 6%, and 6.3%.
How much dividend income?
A risk to its future dividend returns is any delay in its transition to smoke-free nicotine substitutes. This could give the advantage to competitors pursuing the same strategy. Another is tighter regulation on tobacco and nicotine products, which could restrict sales or raise compliance costs.
Even so, consensus analysts’ projections are that British American Tobacco’s earnings will grow by an average 4% a year over the medium term. And it is this that ultimately powers dividend growth over time.
Based on the forecast 6.3% yield, my £20,000 holding in the company would make £17,490 after 10 years and £111,734 after 30 years. This reflects the dividends being reinvested in the stock to harness the power of dividend compounding.
On this basis, the holding’s value would be £135,725 by the end of the 30 year-year period. And this would pay a yearly dividend income of £8,551!
Share price gains too?
Another part of British American Tobacco’s appeal to me as a passive income holding is its potential for price gains. These, like dividends, are also driven by earnings growth over the long term. And in this case, the share price is already markedly lagging its ‘fair value’, in my view.
Discounted cash flow (DCF) analysis identifies where any stock should trade by projecting future cash flows and discounting them back to today. Some analysts’ DCF modelling is more conservative than mine, depending on the variables used.
However, based on my DCF assumptions — including an 8.7% discount rate — British American Tobacco shares are 37% undervalued at their current £43.13 price.
This implies a fair value for the shares of around £68.46 — much higher than where it trades today. And because asset prices can trade towards their fair value in the long run, it suggests a potentially superb buying opportunity to consider today if those DCF assumptions hold.
My investment view
The firm’s high yield is underpinned by years of consistent distributions. It reflects a management team that has long prioritised returning cash to shareholders. This is supported by steady expected earnings growth, which should also drive share price gains towards fair value over time.
Consequently, I will be buying more British American Tobacco shares soon. And other high-yielding and deeply-discounted stocks have also caught my attention in recent weeks.
