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£10,000 invested in the FTSE 100’s British American Tobacco (LSE: BATS) a year ago would be worth much more today.
That amount would have bought an investor 423 shares in the firm at the 23 April 2024 opening price of £23.60. At today’s opening price of £31.99, these are valued at £13,531 – a profit of £3,531 on the share price alone.
However, the stock has also been one of the most reliable dividend payers in the top-tier index for several years.
From 23 April 2024 to today, it has handed an additional 236p per share to stockholders in dividends. This means those 423 shares would have made another £998 in these payouts.
This gives a total profit over the year of £4,529 on a £10,000 holding – a return of over 45%.
By comparison, the FTSE 100’s total return (benchmark price performance plus average yield) over the same period was just 3.53%.
As a long-time holder of the stock, I am a happy chap. I would be even happier if I thought these sorts of returns could be sustained this year.
So I took a closer look to find out.
The key driver of share price and dividends
The principal driver of a company’s share price and dividends over time is earnings growth.
A risk to British American Tobacco is the cut-throat competition in its business sector. Another is that its ongoing strategic shift from combustible to smoke-free products falters for some reason.
However, in 2024 it added 3.6m to a total of 29.1m to smoke-free products, which now account for 17.5% of its revenue. And its objective remains to be a predominantly smokeless business by 2035.
An unexpected boost to earnings might come from Washington’s increasingly hard line on Chinese imports. US firms have increased their lobbying for a clampdown on unauthorised Chinese-made e-cigarettes and vapes sold in the country.
American tobacco firms estimate that these account for around 70% of almost $13bn of US vape sales annually. March saw three US Congressmen support such a crackdown in a letter sent to the government.
However, even without any such boost, analysts forecast that British American Tobacco’s earnings will increase 16% a year to end-2027.
Is the share price undervalued?
In my experience as a former senior investment bank trader, asset prices tend to converge with their fair value over time.
In British American Tobacco’s case, there is plenty of room for continued share price gains based on this.
A discounted cash flow analysis shows the stock is 52% undervalued at its current £31.99 price. Therefore, the fair value for the shares is £66.65, although market vagaries could push them lower or higher.
What’s the dividend yield outlook?
In 2024, British American Tobacco paid a dividend of 235.52p, giving a current yield of 7.4%. Consensus analysts’ forecasts are that the payouts will increase to the end of 2027 at minimum.
More specifically, the projections are for payments of 245.4p in 2025, 252.8p in 2026, and 264p in 2027. Based on the current share price, this would generate respective dividend yields of 7.7%, 7.9%, and 8.3%.
Therefore, given its strong earnings growth prospects, extreme undervaluation, and high yield I will buy more of the stock very soon.
