Passive investors should instead buy this spectacular dividend stock with a yield close to 10%

Tobacco companies were once among the darlings of the stock market. With cash flow growing each year, they have made shareholders a lot of money in the long term. But that has changed in recent years.

Over the past 10 years, British American Tobacco (NYSE:BTI) — one of the world’s largest tobacco and nicotine companies — produced a negative total return of 6%, while the S&P500 is up 231%. This includes the strong dividend payments it distributes to shareholders each quarter.

Today it’s dividend yield rose to just under 10%. As tech stocks reach new all-time highs, this forgotten tobacco giant looks increasingly undervalued. Is British American Tobacco an income investor’s dream right now?

Smokable business is declining, but cash flow is strong

British American Tobacco has some of the oldest cigarette brands in the world. These include Dunhill, Newport and Camel. Even though these brands have maintained their market share in the cigarette industry for decades, overall smoking rates are declining around the world, which is affecting shipping volumes. To counter the impact of these volume declines on its finances, British American Tobacco has constantly increased the prices of cigarette packets.

You can see the results of this strategy in the company’s consolidated financial statements. British American Tobacco’s revenues are up 5.7% over the last five years, despite the decline in cigarette consumption around the world. Over the next five years, the company expects to generate more than $50 billion in free cash flow. For a company with a market cap of just $68 billion, this shows the discounted potential valuation that British American Tobacco is currently trading at.

But these price increases can’t generate cash flow forever, right? Eventually, most people will quit smoking. This is where its new technological products come into play.

Growth may come from new nicotine products

Almost everyone is aware of the harmful effects of tobacco on health. The same goes for the management team at British American Tobacco. Therefore, they are working to manufacture and purchase other nicotine products to replace cigarettes among the adult population. These include nicotine pouches, electronic vapor devices and non-burning cigarette devices. These products may have fewer harmful health effects than cigarettes.

Shareholders should also benefit. The company’s new categories segment grew revenue 21% on an organic basis at constant currency in 2023 and is soon expected to reach $5 billion in annual revenue. Of course, since this is a global company, this can be affected by exchange rates. This segment finally achieved profitability last year, generating positive contribution profit for British American Tobacco for the first time.

The story continues

Over the next 10 years and beyond, these new products could drive the company’s volume growth and hopefully offset the potential decline in profits that will affect the cigarette sector.