Shares in tobacco giant British American Tobacco (LSE: BATS) have collapsed over the past 12 months, falling a staggering 32% since the end of October last year, excluding dividends. Over the same period, the FTSE 100 index has declined by 7%, excluding dividends.
Including dividends, British American has produced a total return of -27%. The FTSE 100’s total return is just -3%.
In my mind, these declines have only made the stock more attractive. At the time of writing, the shares support a dividend yield of 5.8%, and the payout is covered 1.5 times by earnings per share (EPS).
British American has a track record going back several decades of dividend increases, and this is likely to continue. The company is expected to report EPS growth in the high single-digits for the next few years.
Also, right now, the shares look cheap. They’re changing hands for just 11.7 times forward earnings, one of the lowest valuations ever awarded to the stock. Only two years ago, investors were willing to pay a P/E of 22 to get their hands on the shares.
Why has there been such a sudden change in investor sentiment? I think there are several reasons behind the exodus.
Firstly, regulators around the world are cracking down on so-called reduced risk tobacco products. These products have been touted a the next big thing for the tobacco industry, producing potentially billions in additional revenue. It now looks as if these products will fail to live up to the hype surrounding them. Another factor that seems to be weighing on the stock is the general marketwide rotation out of defensive income stocks and UK equities.
Despite these factors, I believe now is a great time to buy British American. Concerns about tobacco regulation are nothing new, and the company has always been able to come up with new ways to grow revenue. The low valuation also gives a sizeable margin of safety.
Down around 10% over the past 12 months, Reckitt’s problems are self-inflicted. A lack of investment at some of its principal divisions means earnings are set to fall 2% for 2018, the first EPS decline since 2013.
However, management and the City are both confident the group can return to growth in 2019 and I reckon it’s a good time for investors to buy ahead of this recovery.
Just like British American, Reckitt’s problems have pushed the stock’s valuation down to a level not seen for several years. Today, the shares are changing hands for 19.5 times forward earnings, around a fifth below the five-year average of 25.
On top of the attractive valuation, there’s also a dividend yield of 2.8% on offer. The payout is covered twice by EPS, so there’s no risk to the payout with falling earnings.
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Rupert Hargreaves owns shares in British American Tobacco. 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.