Given that the FTSE 250 has recorded a total return of around 9% per year in the past 20 years, shares seem to be a good long-term investment. This would have turned £100,000 into £280,000 provided that the returns have not been reinvested.
However, these are the returns of an index fund, including overvalued companies that seem to do worse in the long run. Buying undervalued dividend champions and reinvesting the dividends would have probably turned £100,000 into £1,000,000 in 20 years’ time!
In this article, I am going to cover British American Tobacco (LSE:BATS) to see if the company meets the description mentioned above.
British American Tobacco’s future
Tobacco stocks seem to be highly unpopular among investors, both in the UK and abroad. This is mostly due to the fact that numerous laws prohibit public smoking, promotion and advertising of cigarettes, whereas a healthy lifestyle gets more and more popular among consumers.
Nevertheless, managements of large and flexible companies like British American Tobacco seem to understand that. According to the corporate website, the company has an ambition to “transform tobacco with a choice of potentially reduced risk products”. Thus, the product range of the company does not only include traditional cigarettes, but also vapour and heating products as well as oral products. These are popular among consumers that aim to give up the smoking habit.
Even though vaping products seem to be disfavoured by US lawmakers, chief executive Jack Bowles says that the company is “well-placed” to address these challenges.
Imperial Brands and British American Tobacco
British American Tobacco shares currently yield a dividend of about 6-7% per year. This is not very high compared to its rival company Imperial Brands’ (LSE:IMB) shares, which yield 12% in dividends alone. However, in comparison to Imperial Brands, British American Tobacco is not as indebted.
One of the greatest concerns with tobacco companies is their high leverage, which makes them riskier than less indebted companies. Both of the companies’ liabilities exceed the value of their assets, which means that their book value per share is negative. Most investors aim to buy a company whose book value per share is greater or equal to the share price.
Nevertheless, in the case of British American Tobacco, the net gearing ratio – an indicator that compares debt to book value – is way lower than that of Imperial Brands, which means that British American Tobacco is less indebted than Imperial Brands.
Moreover, the price-to-earnings (P/E) ratio of British American Tobacco is lower than 10, whereas the same indicator of Imperial Brands is greater than 18. This can be compared with the FTSE 250 P/E ratio of 21, which means that British American Tobacco’s shares are more undervalued than both Imperial Brands and the FTSE 250. The earnings growth of British American Tobacco is also better than that of Imperial Brands.
This is what I would do
Overall, I think British American Tobacco is an investment that is worth considering. However, I would be more cautious given that its balance sheet might be a concern for a defensive investor.
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Anna Sokolidou does not own any shares of the companies mentioned in this article. The Motley Fool UK has recommended Imperial Brands. 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.