FTSE 100 tobacco and nicotine products manufacturer Imperial Brands (LSE: IMB) is down 13% from its 26 April 12-month high.
Given that yields rise as share prices fall, this has pushed up its payout to a very eye-catching 8.4%.
Only a handful of FTSE stocks have dividends over 8%, and this is one of the reasons that I bought it recently.
Now in my mid-50s, I am focusing more on dividend shares rather than growth ones. Basically, the older I get, the less time I want to wait for a stock to recover from any shocks.
Is it undervalued?
This said, a major price drop in a high-yielding stock could wipe out any gains made in dividends. So, I also look for shares that appear undervalued against their competitors to lessen the chance of this happening.
On the key price-to-earnings (P/E) stock valuation measurement, Imperial Brands trades at just 6.4.
This looks very cheap compared to the peer group average of 12.2. This comprises British American Tobacco that’s admittedly lower at 6.2, Altria Group at 9.3, Japan Tobacco International at 14.1, and Philip Morris International at 18.8.
A discounted cash flow analysis shows the stock to be around 58% undervalued at its present price of £17.55.
Therefore, a fair value would be around £41.79, although this does not necessarily mean it will ever reach that level.
How’s the business transition going?
The company’s ongoing switch from tobacco to nicotine replacement products appears to be going well so far.
2023 saw reported operating profit growth of 26.8% to £3.4bn. Earnings per share also increased sharply – by 52.1% to 252.4p.
Its nicotine replacement goods (including vapes and patches) saw net revenue up 26% compared to 2022. The rollout of these products in Europe was particularly successful last year, with revenues increasing 40%.
One risk in the stock is that this transition falters, allowing its competitors to gain market share at its expense. Another risk remains future legal action for health problems caused by its products in the past.
Such problems are a key reason why many ethical investment funds avoid tobacco companies. And this has been a factor in its lower share price recently.
This misses a key point, in my view. As a former heavy smoker myself, I now have good cause to be very anti-tobacco products, and I am.
However, companies such as Imperial Brands are in the best position to help drive the change away from these.
Additionally, given the amount spent on cigarettes for 40 years, I think they owe me!
Big passive income generator
The yield Imperial Brands pays can generate very big passive income over time. £10,000 invested right now would make an additional £840 this year in dividend payouts.
Reinvesting dividends averaging 8.4% a year would culminate in a total investment pot of £23,096 after 10 years. This would pay me £1,856 in passive income each year, or £155 a month.
After 30 years, provided the yield averaged the same, I would have a £123,200 investment pot, paying me £9,893 a year, or £824 every month.
It’s still probably nowhere near what I spent on cigarettes over 40 years, but it’s a start.
This post was originally published on Motley Fool
