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British American Tobacco Plc’s Two Greatest Strengths

When I think of cigarette manufacturer British American Tobacco (LSE: BATS) (NYSE: BTI.US), two factors jump out at me as the firm’s greatest strengths and top the list of what makes the company  attractive as an investment proposition.

british american tobacco / imperial tobacco1) Consumable products

A business trading in consumable products tends to make an attractive investment proposition. There’s nothing quite like the steady stream of cash generated from constant repeat purchasing to warm investors’ hearts. With tobacco products, customer loyalty and habitual buying is even more deeply entrenched than for other consumables. After all, the customers are addicted to the product to the last soul: there’s a strong compulsion to repurchase with predictable regularity, much more so than when a packet of soap powder runs out.

The consistent cash flow that tobacco companies like British American Tobacco enjoy makes it possible to plan with a reasonable degree of certainty and to reward investors regularly. In common with other cigarette producers, we see evidence of this in the high levels of debt the firm carries and in the progressive-dividend policy, which the firm supports with a share buy-back scheme.

2) Rising earnings per share.

BATS puts its cash flow to use by paying a generous dividend and pumping up that payout’s effect for investors by buying back its own shares. The record of earnings- and dividend-per-share figures is impressive:

Year to December 2008 2009 2010 2011 2012 2013
Revenue (£m) 12,122 14,208 14,883 15,399 15,190 15,260
Net cash from operations (£m) 3,539 3,878 4,490 4,566 4,427 4,436
Adjusted earnings per share 129.6p 153.8p 176.7p 195.8p 208.6p 217.4p
Dividend per share 83.7p 99.5p 114.2p 126.5p 134.9p 142.4p

Right now, the forward dividend yield is running at about 4.6% with forward earnings covering the payout around one-and-a-half times. However, it’s worth noting that industry volumes are in long-term decline, which reflects in BATS stagnant revenue and cash flow figures.

What now?

British American Tobacco’s dividend looks attractive, but the firm’s flat-looking business makes me nervous. So what should I look for to pin down a solid dividend-grower with potential to deliver on total investor returns?

Dividend investing is not always as simple as it might appear. That's why the Fool has released a special report featuring 5 Golden Rules for Building a Dividend Portfolio. The rules can help avoid some of the pitfalls waiting to trap dividend-hunting investors.

 If you're thinking of taking the plunge with high-yielding shares, I recommend reading this report first. To get your copy, click here.

Kevin does not own shares in British American Tobacco.