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Will this 7% FTSE 100 dividend stock help you retire early or leave you with huge losses?

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A quick look at British American Tobacco (LSE: BATS) would suggest a stock that’s being criminally undervalued by the market.

It may not be fashionable to say so but the addictive nature of its products has made this FTSE 100 stalwart a long favourite for those seeking great profits growth. And broker forecasts would suggest nothing has changed in this regard, with bottom-line advances of 5% and 7% forecast for 2019 and 2020, respectively.

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Yet despite the appearance that it’s ‘business as usual’, British American Tobacco changes hands on a bargain-basement forward P/E ratio of just 9.7 times, giving value-chasing investors reason to celebrate for a figure that’s also long, long below the firm’s historical multiples.

7% dividend yields looking safe

There’s plenty for income investors to cheer as well. Underlining expectations that profits will continue their traditional ascent, number crunchers are predicting 2018’s 203p per share dividend will creep to 209p this year before sprinting to 222.8p in 2019. Subsequent yields sit at a handsome 6.8% and 7.3%, respectively.

But some may point out that yields may be big but they certainly aren’t that well protected, at least by conventional standards. Forecast earnings for the medium terms means that dividends are covered just 1.5 times through to the close of 2020, some way below the regarded safety standard of 2 times and above.

Cynics need only look at British American Tobacco’s balance sheet before casting judgment though, as this suggests the Footsie firm has more than enough financial gumption to make good on current estimates. It’s always been a brilliant cash generator but, in 2018, helped by the acquisition of Reynolds American, free cash flow more than doubled year-on-year to a staggering £7.7bn.

But I’m not buying, because…

So on the face of it the question whether to buy up British American Tobacco shares would appear to be a no-brainer, right?

Scratch a little harder though, and suddenly the cigarette manufacturer loses its sheen. Okay, its investment outlook in the medium term may be compelling. But over a longer time horizon the profits prospects for this blue-chip are loaded with risk.

I’ve talked in some detail about the toughening legislative landscape for the likes of British American Tobacco, and there’s been additional worrying developments in recent weeks for Big Tobacco.

New York is the latest US state to have taken steps in recent days to raise the minimum age for buying combustible and e-cigarettes, from 18 to 21. And the fight against vaping products looks set to intensify after data showed the number of teenagers using these new-age technologies leap to 4.9m in 2018, up 1.3m year-on-year.

The head of the US Food and Drug Administration, Scott Gottlieb, has called the take-up of e-cigarettes by younger consumers as “one of the biggest public health challenges.” This fresh data raises fears of crushing legislative action on these products, viewed as the saviour of the tobacco sector as their traditional goods face extinction.

Growing tension over the future legislative environment has caused British American Tobacco’s shares to halve in value, from the record tops above £56 struck in June 2017, and there’s clearly plenty of reason to expect them to keep reversing. This FTSE 100 income stock is one to avoid at all costs, in my opinion… it could seriously damage your wealth.

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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.

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