As they approach retirement, many investors are turning to a dividend-focused investment strategy. That’s a solid plan, but there’s a risk that trying to generate the largest passive income stream will lead to a risky portfolio.
That’s the dilemma when you’re considering buying British-American tobacco(NYSE: BTI) and the high dividend yield of 8.4%. Here’s what you need to know about this stock before adding it to your dividend portfolio.
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If you’re looking at British American Tobacco, chances are you’ve come across this stock because of its high yield of 8.4%. On an absolute level, that’s a pretty big number, but it becomes even more impressive when you compare it to other returns. For example the S&P500 (SNPINDEX: ^GSPC) has a paltry yield of 1.2% and uses the average stock of consumer goods Consumer Staples Select Sector SPDR ETF(NYSEMKT: XLP) as a proxy, has a return of 2.6%.
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From this perspective, British American Tobacco seems like a stock that could give you a huge income stream. But the big question is: can you actually rely on that income stream for the rest of your life?
The yield alone is impressive, but you just can’t tell. You need to dig deeper into the company’s business to assess whether it can continue to pay you that big dividend year in and year out. This is where the problems start for British American Tobacco and why the dividend yield is so high.
British American Tobacco is a tobacco company. The main activity is the sale of cigarettes. Cigarette smoking has fallen out of fashion around the world as the health risks it poses have led consumers to avoid the habit and governments have made efforts to discourage consumers from smoking (with actions such as high tax rates and legally required warnings on packaging). The high yield offered by British American Tobacco is a sign that Wall Street is concerned that the dividend may not be sustainable in the long term.
Right now, British American Tobacco is hedging its dividend (if you take out one-off costs in 2023), so there’s probably very little risk of a dividend cut in the near term. The nature of cigarettes is such that customers are generally quite loyal, which has allowed the company to raise prices regularly. This helped offset the negative impact of declining volumes. But you can’t ignore the volume drops.
In the first half of 2024, the company’s combustibles group, which largely consists of cigarettes, saw a volume decline of 6.9%. In 2023 the decrease was 5.5%. And in 2022 the decline was 5.2%. If another consumer goods company saw such a trend, you probably wouldn’t buy it.
In fact, in 2023, British American Tobacco made a very troubling accounting change regarding its US operations. It’s a complicated shift, but essentially the company admitted that the company could be worthless in 30 years.
That step resulted in a large one-time expense, but to be honest, thirty years is a long time. However, given the volume trends mentioned, you have to wonder how long this company can continue to sustain the dividend if even the company expects the volume decline to end at zero. At some point, it appears that price increases will accelerate rather than offset the decline.
Ultimately, British American Tobacco is no different from the competition when it comes to what happens to its operations. And like its competitors, the company is trying to use the profits it generates from cigarettes today to invest in new businesses that it hopes will offset the continued volume declines it faces.
To that end, the company has invested in things like vapes and pouches. It has had some success. However, the flammable substances division still generates four times the turnover of the non-flammable substances division.
In other words, there is still a long way to go before British American Tobacco finds a replacement for its slowly deteriorating cigarette business. If you’re hoping that British American Tobacco can provide you with an income stream for the rest of your life, that’s probably not something you should count on, given the state of the company’s core business.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco Plc and recommends the following options: long January 2026 $40 calls on British American Tobacco and short January 2026 $40 puts on British American Tobacco. The Motley Fool has a disclosure policy.
Could buying British American Tobacco shares today be good preparation for life? was originally published by The Motley Fool
