£6,000 in savings? Here's how I would try to turn that into £611 a month of passive income!

You share FTSE 100 heavy weight British American cigars (LSE: BATS) have long been a rich source of income for me. This is money made with little effort and as a former smoker, I feel fully entitled to benefit from the firm's generosity.

This 230.89p company paid a dividend of €8.8 per share last time and the annual yield is 26.33%. In contrast, the average yield of the FTSE 100 is just 3.5% plus value FTSE 250 only 3.3%.

Requirement not to measure properly

High yield stocks designed to maximize income are a great start. But there are two other qualities that I look for, starting with reducing the share price. In my experience, this reduces the chance of dividend gains being wiped out by a loss in share price in the event that I sell the stock.

British American Tobacco currently looks undervalued to me in several key stock valuation methods. On a price-to-sales ratio (P/S), for example, it currently trades at 2.3 compared to a competitor's ratio of 3.2.

A discounted cash flow analysis using other analysts' calculations and my own shows that the company is not 60% off the ground. Therefore, the fair value of the stock would be £65.83, although it could be lower or higher.

The need to grow

The third quality I look for in an income stock is a strong business outlook. Ultimately, growth in earnings power increases the company's value and dividends over time.

British American Tobacco is moving away from combustible tobacco products into the realm of non-combustible nicotine. It aims to have 50m consumers of its smoke-free products by 2030. It also targets 50%+ of revenue to be generated from this sector by 2035.

By the end of 2023, it had 23.9 million such customers accounting for 16.5% of its revenue.

The main risk to its growth prospects is that this strategic shift has stalled for some reason. Another case is damages allegedly caused by smoking. Indeed, October 18 saw a Canadian court-appointed mediator propose a C$32.5bn (£18.1bn) settlement with British American Tobacco, Philip Morrisagain Japanese cigarettes to resolve such a dispute in the country.

However, as it stands, consensus analyst estimates are that the company's earnings will grow 44.4% annually through 2026.

How much income can I get?

£6,000 invested in 8.8%-yielding British American Tobacco shares will produce £528 in dividends in the first year. Over 10 years on the same basis, this will rise to £5,280 and over 30 years to £15,840.

However, if these shares were used to buy more shares, the return would be much greater.

Doing this ('dividend compounding') on the same average yield would make £8,419 in dividends rather than £5,280. And over 30 years on the same basis, payments will increase to £77,273, not £15,840.

Meanwhile, the total value of British American Tobacco will be £83,273. This would be paying £7,328 in annual income, or £611 every month!

It is also not guaranteed that the purchasing power of money would have been reduced in any way by inflation at that time, of course. However, it emphasizes how a small investment can grow into a very large income over time.