FTSE 100 tobacco and nicotine replacement products manufacturer British American Tobacco (LSE: BATS) is overlooked by many on ethical grounds.
As a former heavy smoker myself, I understand this. But I am not ignoring the stock. Rather, I have used it to recoup some of the vast amount of money I spent on cigarettes over 35 years
Big dividends
In 2022, the company paid 217.8p a share in dividends. Before that it paid 215.6p in 2021, 210.4p in 2020, and 203p in 2019. These yielded 6.7%, 7.9%, 7.8% and 6.5%, respectively.
Last year, it paid 230.89p. With the shares at £24.64, this made the yield 9.4% — one of the highest in the FTSE 100.
And analysts forecast that the yields will rise to 9.6% in 2024, 10% in 2025, and 10.5% in 2026.
Huge passive income streams
Passive income is money made from minimal effort, such as dividends from shares. Unlike when I smoked, my pleasure from these regular payments is not accompanied by a hacking cough!
So, £17,000 (the average UK savings account amount) would buy 690 shares in British American Tobacco.
These would pay £1,598 in dividends in the first year, based on the current 9.4% yield.
The same amount would be paid yearly if the dividend stayed the same and I withdrew the payments as cash. So, after 10 years, an extra £15,980 would have been made, and after 30 years an additional £47,940.
However, the returns would dramatically increase if the dividends were used to buy more of the shares (known as ‘dividend compounding’).
An extra £26,361 would be made instead of £15,980 after 10 years by doing this. After 30 years, an additional £265,090 would have accrued instead of £47,940.
The total British American Tobacco investment would be worth £282,090 by then. It would generate £26,516 every year in passive income, or £2,210 each month!
Share price undervaluation
Making spectacular returns is no use if they are then wiped out by share price losses, of course. Consequently, I always look for high-yield stocks that are also undervalued against their peers. That way, there is less chance of big price falls happening over the long term.
A risk in the shares is that its competitors are more successful in transitioning to nicotine substitute products. There also remains a threat of legal action from former smokers for alleged damage done to their health.
However, analyst forecasts are that the firm’s earnings will increase by a whopping 51.7% a year to the end of 2026.
Moreover, a discounted cash flow analysis shows the stock to be 53% undervalued at its present price of £24.64. So, a fair value per share would be £52.43, although they may go lower or higher than that.
If I did not already own the shares, I would buy them today for their very high yield and extreme relative undervaluation.
The post 690 shares in this overlooked FTSE dividend gem can make me £26,516 a year in passive income! appeared first on The Motley Fool UK.
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Simon Watkins has positions in British American Tobacco P.l.c. The Motley Fool UK has recommended British American Tobacco P.l.c. 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.
