For many stock pickers British American Tobacco (LSE: BATS) may be a mightily-tempting dividend choice right now.
It can be picked up for next to nothing with the FTSE 100 tobacco titan trading on a forward P/E ratio of just 12.5 times. For those seeking electric dividend growth in particular, this low valuation may seem too good to be true — the business has hiked the full-year payout by almost 40% over the past five years alone, culminating in last year’s 195.2p per share payment.
And City analysts expect dividends to keep growing at a healthy rate. In 2018, it’s expected to rise to 203.4p, meaning that British American Tobacco carries a Footsie-smashing yield of 5.5%.
However, there is a very good reason why the company can be secured on such a low earnings multiple, and this was underlined by latest trading details released today.
While declaring it has enjoyed “good” earnings growth at constant currencies so far in 2018, the impact of significant adverse currency movements versus the pound will result in a headwind of 9% for the first half and 6% for the year on the whole.
I am more concerned about other details in the release which again cast doubt over British American Tobacco’s long-term profits outlook, though. While market share grabs by its so-called Global Drive Brands, including Lucky Strike and Dunhill, are stopping earnings from falling off a cliff, I’m worried by the rate at which total cigarette consumption is dropping. The firm itself estimates that global cigarette volumes will fall 3.5% in 2017.
What’s more, today’s update also cast fresh doubts on the company’s ability to offset declining demand for its traditional combustible products by hiking investment on the development of next-generation technologies. In Japan, British American Tobacco said that sales of its tobacco heating products have slowed recently, mirroring similar observations of the other big tobacco merchants.
These tough conditions have caused investors to flee the manufacturer and thus British American Tobacco’s market value has shrunk by a third over the past 12 months alone. With trading becoming ever-tougher, it isn’t a push to imagine this share price deterioration continuing. I would avoid the business right now despite its undemanding earnings multiple.
A much better selection!
I believe investors seeking abundant dividends would be better served by ploughing their cash into Persimmon (LSE: PSN) instead.
The FTSE 100 business isn’t without its own earnings pressures, of course. As I alluded to last time, stuttering house price growth is likely to see the gigantic annual profit rises of yesteryear slowing to a competitive crawl from this point onwards.
However, such is the size of the homes shortage in Britain that I reckon Persimmon is still in great shape to keep delivering healthy profits rises year after year. And this should keep dividends on the right side of ‘generous’.
City brokers share my optimistic take and are predicting a reward of 235p per share for 2018, yielding a sensational 8.4%. Combined with its dirt-cheap forward P/E ratio of 10.5 times, I believe Persimmon is worthy of serious attention right now.
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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.