FTSE tobacco and nicotine products manufacturer Imperial Brands (LSE: IMB) has a history of paying high dividends. Over the past four years, working back from 2022, it paid 7.6%, 8.9%, 10.1%, and 11.3% respectively.
Additionally, in all but 2019’s case, these were mainly well-supported by the dividend cover ratios. Again working back from 2022, these were 1.88, 1.78, 1.85, and 1.32, respectively. Above 2 is considered good, while below 1.5 indicates the risk of a dividend cut.
The total dividend payment for 2023 is 146.82p. This gives a yield of 7.7% based on the current share price of £18.99.
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At this price, just under £10,000 would buy me 526 shares in the firm.
Dividend compounding magic
‘Dividend compounding’ is the same principle as compound interest in bank accounts, but rather than interest being reinvested, dividend payments are. The difference in returns between withdrawing dividends paid each year or reinvesting them is massive.
For example, my 7.7% dividend return on £10,000-worth of Imperial Brands shares would make me £770 in the first year If I withdrew that, I would receive another £770 the following year, provided the dividend remained the same.
If I kept withdrawing my payouts and the dividend stayed the same, I would have made £23,100 after 30 years.
However, if I reinvested the dividends into Imperial Brands stock, I would have £92,570 after 30 years, given the same average yield! That would pay me £6,618 a year in passive income, or £552 every month.
An added regular investment bonus
Great though this is, it could be even better if I continued to save every month — even £500.
If I did this, I could have the same £6,618 a year (or £552 every month), after just eight years!
After 30 years, provided the yield averaged 9%, I would have a total investment pot worth £805,830. This would pay me £59,331 a year in passive income, or £4,994 every month.
Inflation would affect the buying power of my income. However, it shows that big passive income can be generated from a much smaller initial investment.
Will I buy the stock?
There are risks in the shares. One is issues in the timing of its transition away from smoking products. Another is any litigation from the effects of its products in the past.
For me though, it has three very appealing qualities.
First, it has a high yield.
Second, it looks undervalued. Specifically, it trades on a price-to-earnings (P/E) ratio of just 7.1, against a peer group average of 11.
A discounted cash flow analysis shows the stock to be around 51% undervalued at its current price of £18.99. Therefore, a fair value would be around £38.76, although this does not necessarily mean it will ever reach that level.
A £1.1bn share buyback announced on 5 October is also positive for potential share price gains. This will run until 30 September 2024.
And third, the business looks to me to be on an uptrend. Its full-year 2023 results showed operating profit up 26.8% from 2022, to £3.4bn. Additionally, basic earnings per share rose 52.1% over the same period, to £252m.
For these three reasons, Imperial Brands will go on my buy list for when a spot opens up in my high-yield portfolio.
