591 shares in this high yielding FTSE 100 gem can make you £14,873 a year in passive income over time!
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My investment focus in recent years has been on increasing dividend income. This is the best way I have found to make money with little effort – the definition of income.
British American cigars (LSE: BATS) has long been one of the things I have held on to in achieving this. It has all three qualities I look for in such a stock – high yield, strong earnings growth, and market undervaluation, in my opinion.
High yield
In 2023, it paid a dividend of 230.89p, or 8%.
This year, it raised its three interim dividends by 2%. If the final interim dividend increased by the same amount the total payment would be 235.2p. This will yield 8.2% compared to an average of 3.6%. FTSE 100.
Analysts forecast dividends of 246.5p in 2025 and 257.9p in 2026, giving respective returns of 8.6% and 9%.
Strong income growth
Ultimately, earnings growth drives a company’s dividends and share price. The danger this time for British American tobacco is any delay in its transition from tobacco products to nicotine products, I think. This can give competitors doing the same thing a market advantage.
However, as it stands, analysts predict that revenue will increase by a staggering 44% each year until the end of 2026.
Share below par
I am not willing to sell the shares, as long as they continue to produce high yields. However, should I ever need to do so, I would obviously rather not make a loss on what I paid for.
To minimize the chance of this happening, I only buy stocks that are undervalued in two broad steps. First, against the shares of competing firms, based on the key metrics I use. Second, in the value shown by using the company’s future cash flow forecasts.
In the first, British American Tobacco is undervalued on both price-to-book and sales price ratios.
Finally, a discounted cash flow analysis shows that the stock is undervalued at £28.76% by 57%. Therefore, the fair value would be £66.88, although it could be lower or higher, given the uncertainty of the market.
How much income can be made?
£17,000 (the average value of a UK savings account) would buy me 591 shares in the company now. And if right now I had the right money available to do this, I would do it right now.
At an 8% yield, these will pay £1,360 in dividends in the first year. This will rise to £13,600 after 10 years on the same basis and to £40,800 after 30 years.
However, by using dividends to buy more British American Tobacco shares, these payments will increase significantly.
Doing this (‘dividend compounding’) at an 8% yield would produce £20,734 in dividends after 10 years, not £13,600. And after 30 years, dividends paid will rise to £168,907 instead of £40,800.
The total holding amount (in addition to the £17,000 initial investment) would be £185,907. So, if the stock was still yielding 8% (it could be lower or higher), it would generate £14,873 a year in income over that period.
Inflation will reduce the purchasing power of money during that period. However, it shows that small investments can generate large incomes, especially when dividends are compounded.
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