FTSE 100 heavyweight British American Tobacco (LSE: BATS) has long been one of my core high-dividend-paying stocks.
Last year, it paid a total dividend of 230.89p a share, giving a yield on the current £24.19 share price of 9.5%.
This is one of the very highest in any FTSE index and compares to the current 3.8% average of the FTSE 100.
Should you invest £1,000 in British American Tobacco right now?
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How much passive income can be made?
The average savings amount in the UK is £11,000, and this would buy 455 shares in the company.
This number of shares yielding 9.5% would make £1,045 in first-year dividend payments. After 10 years, if the yield averaged the same, then the total passive income would be £10,450.
This is a better return than any UK bank savings account right now. But it is nowhere near what could be made if the dividends were reinvested back into the stock.
This is known as ‘dividend compounding’ and is the same process as compound interest in a bank account.
If this was done, then the total dividend returns over 10 years would be £17,337 instead of £10,450. The total investment pot would be £28,337, paying £2,558 a year in dividends, or £213 a month.
On the same average yield of 9.5%, after 30 years the investment pot would total £188,043.This would generate £16,978 a year in passive income, or £1,415 each month.
Can the high yields continue?
Yields rise and fall with share price movements and dividend payouts. However, sustained earnings growth power share price and dividend rises over time.
In British American Tobacco’s case, adjusted profit from operations in 2023 rose 3.1% from 2022 to reach £12.47bn. Adjusted diluted earnings per share increased 4% over the same period to 375.6p. And adjusted net debt fell 7.4% to £33.94bn.
One risk in the company is that its ongoing transition away from tobacco products to nicotine substitutes is delayed for some reason. Another is any litigation from the effects of its products in the past.
However, consensus analysts’ estimates are that its earnings will grow 50% each year to the end of 2026.
Is there value in the share price?
Given my goal of maximising passive income, I do not want any deductions caused by big share price falls. The chances of this happening are reduced if a share already appears undervalued against its peers, in my view.
British American Tobacco currently trades on the key price-to-earnings (P/E) stock valuation measurement at just 6.4. This compares to an average of 13.3 for its peer group, so it looks very undervalued on this measure.
In fact, a discounted cash flow analysis shows the shares to be around 53% undervalued at their £24.19 current price. Therefore, a fair value would be around £51.47.
There is no guarantee they will ever trade at that price, of course. However, it underlines to me how undervalued they look.
Given this, plus its strong growth prospects (in my view), and its high yield, I will be adding to my holding soon.
