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At What Price Would British American Tobacco plc Be A Bargain Buy?

smokingPatience is one of the key attributes of a successful investor. The likes of US master Warren Buffett have been known to wait years for the right company at the right price.

Now, while buying stocks at a fair price will tend to pay off over the long term, we all love to bag a real bargain.

Today, I’m going to tell you the price I believe would put British American Tobacco (LSE: BATS) (NYSE: BTI.US) in the bargain basement.

Premium price

The shares of British American Tobacco (BAT) are trading at 3,590p at the time of writing, putting the company on a forward P/E of 16 — a premium to the FTSE 100 long-term average of 14.

BAT is the world’s most international tobacco company. The group has factories in 41 countries and its brands sell in more than 200 markets.

The scale of the business, the strength of the brands and the pricing power that comes with an addictive product, give BAT a fantastic operating margin; averaging 35% over the last five years.

This margin is ahead of other companies in the broad ‘consumer goods’ sector, including foods and household cleaning giant Unilever (15%), and even world number one spirits group Diageo (30%).

Rising disposable income in emerging markets is a tailwind for BAT, just as it is for Unilever and Diageo. However, unlike those companies, BAT also faces a headwind: declining volumes in the developed world, as a result of increasing regulation and health education.

At what price a bargain?

In previous articles, I’ve explained why I think Unilever would be a bargain at anything up to the FTSE 100 long-term average P/E of 14, and why I consider Diageo would still be a bargain at a P/E of up to 16; maybe even 17.

So, where do I see BAT’s bargain level relative to these fellow high-quality businesses? Does BAT deserve to rate as highly as Diageo, or does it merit a rating more like that of Unilever?

My view is that, despite BAT’s top-notch operating margin, the long-term headwinds tobacco companies face in the developed world, mean I’d want a discount to the earnings rating I’d pay for Diageo, and reckon a rating closer to Unilever’s would be about right. As such, I think BAT’s current P/E of 16 is above the bargain basement.

I don’t have to go back too far to find BAT on a more attractive rating. In a regular quarterly review of the Footsie’s sector heavyweights, I’ve been able to highlight BAT for Motley Fool readers on a P/E as low as 13.9 (at a share price of 3,109p) in October 2013. And on three occasions since, the company has been available on a P/E of not much above 14 — most recently in January this year, when the P/E was 14.2 (at a share price of 3,238p).

In line with my view that BAT merits a similar rating to Unilever, I reckon the tobacco group would be in the bargain basement at a P/E of up to, say, 14.5. As earnings forecasts currently stand that equates to a share price of no more than about 3,250p.

But whether you agree with my bargain valuation of BAT or not, deciding on a valuation you are willing to pay for a company, and having the patience to wait for it, can enable you to target a £1 million portfolio.

The magic million isn't as far-fetched as it may sound. To find out why, help yourself to a FREE copy of the Motley Fool guide, "10 Steps To Making A Million In The Market".

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G A Chester has no position in any shares mentioned. The Motley Fool UK owns shares in Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.