I sold my Lloyds (LSE: LLOY) recently for two key reasons.
First, it trades too much like a ‘penny share’ for my taste. Strictly speaking, it is not one as its market capitalisation is too big. But at just 56p a share, every penny it moves is nearly 2% of its value!
Second, it does not pay big enough dividends for me. Since I turned 50 a while ago, I have focused on buying shares with high yields so I can increasingly live off the income.
These shares also need to appear set for growth, as this is what drives increases in dividends over time.
And they need to look undervalued, as this lessens the chance of big share price falls wiping out dividend gains.
I invested part of the proceeds from the Lloyds sale into British American Tobacco (LSE: BATS) based on this strategy.
Growth outlook
Consensus analysts’ forecasts are for Lloyds earnings to grow by 4.9% a year to the end of 2026. Earnings per share are forecast to increase by 8.4% a year over that period. And return on equity is predicted to be 11.3% by the same point.
For Lloyds, one risk is declining profit margins as interest rates fall in the UK. It also faces legal action for mis-selling car loans through its Black Horse insurance operation.
British American Tobacco, by contrast, is forecast to see its earnings increase by 49.4% a year to end-2026. Earnings per share are expected to increase by 47.8% a year over that period. And return on equity is predicted to be 16.4% by the same point.
For British American Tobacco, a risk is potential legal action for health problems caused by its products in the past. Another is a loss of competitive advantage caused by any delays in its transition to nicotine replacement products.
But overall, a clear win for the tobacco firm in this category, in my view.
Share price valuation
Using the key price-to-earnings (P/E) measurement, Lloyds currently trades at 7.8, against a peer group average of 7.6. So it looks slightly overvalued against its peers.
British American Tobacco trades at a P/E of 6.6, against a peer group average of 13.2. So it looks clearly undervalued.
Another clear victory for British American Tobacco, I think.
Dividend yields
Lloyds paid 2.76p a share in dividends in 2023, giving a yield on the current 56p share price of 4.9%.
British American Tobacco paid 230.89p in the same year, giving a yield on the present £24.76 share price of 9.3%.
The difference in yields is massive when it comes to the payouts I would receive over time.
For example, £10,000 invested in Lloyds at an average of 4.9% will give me an investment pot of £43,362 after 30 years. This would pay me £2,069 a year, or £172 a month in dividends.
But £10,000 invested in British American Tobacco at an average of 9.3% will result in more than three times the Lloyds amount.
Specifically, £161,068 after 30 years. This would pay me £14,251 a year, or £1,188 a month!
So, another huge win for the tobacco firm here as well, making three out of three.
Consequently, I am extremely pleased with my decision to swap Lloyds for British American Tobacco and would do the same again today.
This post was originally published on Motley Fool
