Why British American Tobacco plc Is A Bad Share For Novice Investors

I’m doing a tour of the FTSE 100‘s top shares, and offering some thoughts about their suitability for novice investors. And today I’m turning my attention to British American Tobacco (LSE: BATS) (NYSE: BTI.US).

You can see from the title that I’m not recommending it for novices, but first let me tell you what I think is great about it as an investment (I’m making no comment on investment ethics, by the way, as that’s for you to decide).

Great rewards

How often do you find a company that has been growing its earnings per share year after year, has been doing the same with its dividends and offers an average yield of around 4.5%, and has seen its share price multiply more than 12-fold since the start of 2000? Well, that’s what has happened to British American Tobacco, and those who have held the shares over the long term are considerably richer today as a result.

It also easily fulfills one of my favoured requirements, in that it’s a very easy business to understand — the firm sells tobacco. Okay, it does it through a number of subsidiaries and holdings, but it all boils down to the same thing. It sells just one product.

So if it’s done so well for others, why isn’t it for you?

Hold for 20 years?

It’s another Warren Buffett thing.

He famously once said that if a share doesn’t look like you’d want to hold it for 20 years, you shouldn’t hold it for a single day. Will tobacco be as big a seller in 20 years as it is now? I really don’t think so. I think British American Tobacco is a once-successful share that is on the turn, and the signs of bad times are already appearing.

Look at earnings growth — 19% in 2008, down to 15% by 2010, only 6% last year, and forecasts for this year and next are similarly in single figures. Now, on today’s share price of 3,365p that might still be good value, I don’t really know. But slowing earnings growth can be a leading indicator of a declining business.

Falling volumes

We’ve also seen signs in the results. At the first-half stage this year, cigarette volumes were down 3.4% with total tobacco volume down 3.2% — the company kept its profits up by shifting its focus to higher-margin prestige brands. And that’s an acceleration in a trend that started in 2012, when we saw full-year volumes decline by 1.6%.

For now, profits are still doing well, but the omens for the next 20 years are not good — and that’s for the industry itself, not just the company.

Finally, if you want an idea for a share that I think really is worth considering for novices, check out the Motley Fool's Top Income Share report. I won't tell you what it is, but I'll tell you one thing -- at more than 5.5%, its dividend yield is better than British American Tobacco's, and the future of its industry is safe.

If you want to know more, click here to get your free copy today.

> Alan does not own any shares mentioned in this article.