FTSE 100 tobacco and nicotine products manufacturer Imperial Brands (LSE: IMB) is one of those shares regularly overlooked by investors.
Companies in this sector, like those in oil, are ethically unpopular nowadays, but this misses a key point, I think.
Such firms are in the best position to drive the change away from these products and to better alternatives. This is one reason why I invest in some of them.
Another is that because they are overlooked, they tend to offer excellent value. And the final reason in the case of tobacco and nicotine product firms is that they pay high dividends.
As a former heavy smoker myself, I think this is the least they owe me!
Regular high dividend payer
In the past four years, working back from 2022, Imperial Brands paid 7.6%, 8.9%, 10.1%, and 11.3% in dividend yields.
Last year, the total dividend was 146.82p. This gives a yield of 7.5% based on the current share price of £19.67.
At this price, just under £11,000 would buy me 559 shares in the firm.
Big passive income generation
So, 559 shares in the company would make me around £825 in dividends in the first year. After 10 years averaging the same yield, I would have another £8,250 on top of the £11,000 or so investment.
Crucially though, these returns could be turbo-charged by reinvesting the dividends paid back into the stock.
This is known as ‘dividend compounding’ and is the same process as compound interest in a bank account. But rather than interest being reinvested, dividend payments are.
If this was done, then the dividend payments after 10 years would total £12,233 instead of £8,250!
This would mean £23,233 in total, paying £1,674 a year in dividends, or £140 a month.
Over 30 years on an average 7.5% yield, the investment pot would total £103,637, paying £7,466 a year, or £622 a month!
Inflation would reduce the buying power of the income, of course. And yields can fall as well as rise, depending on dividend payments and share prices.
However, it highlights that a significant passive income can be generated from relatively small investments in the right stocks if the dividends are reinvested.
Will I buy more of the shares?
One risk in the company is competitive advantage lost due to any slippage in its transition away from smoking products. Another is any litigation from the effects of its products in the past.
For me though, it has two other very appealing qualities aside from its high dividend.
First, despite its recent price rise, it still looks very undervalued against its peers. Specifically, it trades on a price-to-earnings (P/E) ratio of just 8.1, against a peer group average of 14.9.
A discounted cash flow analysis shows the stock to be around 62% undervalued at its current price of £19.67. Therefore, a fair value would be around £51.76, although this does not guarantee it will reach that level.
Second, the underlying business looks strong to me. Its full-year 2023 results showed operating profit up 26.8% from 2022, to £3.4bn. In H1 2024, its adjusted operating profit rose 2.8% year on year. Net revenue growth for its next-generation nicotine products increased 16.8% in the period.
Consequently, I will be buying more of the shares very soon.
This post was originally published on Motley Fool
