The market soared from early 2023. H S&P 500 the index has posted a total return level of 48% over that time, pushing the index’s price-to-earnings gains (P/E) ratio of almost 29.
This is much higher than the long-term market average, with many popular stocks such as apple, Nvidiaand Microsoft trading at even higher multiples. High earnings ratios likely mean high risks for strong future returns. You have to be an optimist to believe that returns over the next 10 years will look like the last 10 for the S&P 500.
So what are investors to do with so many stocks looking expensive? I have a dividend stock that looks extremely attractive compared to the market: British American Tobacco (NYSE: BTI). The company has a dividend yield close to 10% and a dirt cheap earnings ratio. Unlike most stocks, the market is extremely pessimistic about the company’s prospects right now.
Here’s why you should buy British American Tobacco stock for the second half of 2024.
Reduced unit volumes, steady price increases
Investors have pressured tobacco companies because of the accelerating decline in the volume of traditional cigarettes. British American Tobacco has seen an 8% decline in worldwide cigarette sales volume in 2023.
While numbers like this are troubling, investors should remember that tobacco companies are dealing with the effects of conflict around the world, which is weighing on volume numbers. On an organic basis, British American Tobacco posted a 5.3% volume decline worldwide.
The company is able to counter the decline in sales volume with continued price increases on cigarettes. That’s why combustibles revenue is down just 4% in 2023, and a paltry 0.8% if you exclude currency movements, which the company can’t control.
Taking the big picture, it’s clear that British American Tobacco’s cigarette business is doing well despite a big drop in volume. While not a hyper-growth business, its price increases have led to solid consolidated revenue over the past five years.
And this is not the company’s only product division.
Developing in pouches and vaping
In addition to cigarettes, British American Tobacco has invested in new and less harmful nicotine products. The most prominent are the Velo brand of nicotine pouches and the Vuse e-vaping brand.
Organic revenue for vaping products is up 27%, and oral nicotine pouches are up 39% in 2023. Combined, these new categories are approaching $5 billion in annual sales and last year reached segment profitability.
Over the next few years, this segment will finally start contributing to the company’s overall earnings team and free cash flow. It’s still much smaller than the company’s cigarette business, which does more than $20 billion in annual sales worldwide, but vaping and pods are new categories that can help replace legacy cash flows and generate of a sustainable British American Tobacco in the long term.
A sustainable dividend yield of 10%.
Today, British American Tobacco has a dividend that yields 9.2% on a forward basis. That’s much higher than the S&P 500’s rate, which is under 2%, and more generous than a high-yield savings account, which currently pays just under 5%.
A high dividend yield suggests investors are pessimistic about the company’s future earnings, and the stock currently has a cheap P/E of 6.2.
However, I think this is misguided and investors can take advantage of this pessimism right now. British American Tobacco’s annual dividend per share is $2.90 (in dollars). This is funded by free cash flow per share of more than $5. Even if the company’s cash flow doesn’t grow, the dividend is not only sustainable but looks poised to grow.
And with the increase in profits from nicotine pouches and vaping, I think it’s likely that British American Tobacco’s free cash flow per share will be higher In 5 and 10 years from now. For these reasons, the stock looks like a great buy in mid-2024 and an easy one to hold for the long term.
Should you invest $1,000 in British American Tobacco right now?
Before you buy shares in British American Tobacco, consider the following:
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Brett Shaffer has no position in any of the listed stocks. The Motley Fool has positions and recommends Apple, Microsoft and Nvidia. The Motley Fool recommends British American Tobacco Plc and recommends the following options: long Microsoft January 2026 $395 calls, long British American Tobacco January 2026 $40 calls, short British American Tobacco January 2026 $40 calls and short January 2026 calls $405 at Microsoft . The Motley Fool has one disclosure policy.
1 spectacular dividend stock yielding close to 10% to buy for the second half of 2024 originally published by The Motley Fool
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