British American Tobacco (NYSE:BTI), one of the world's top tobacco companies, is often considered a stable income investment. It generates consistent revenue and earnings growth, pays a high forward dividend yield of 7.2%, and trades at less than nine times next year's earnings.

However, British American Tobacco has also consistently underperformed the market. Its stock rose less than one percent over the past decade as the S&P 500 nearly tripled. Even after factoring in reinvested dividends, British American only generated a total return of about 65%.

By comparison, Philip Morris International (NYSE:PM) and Altria (NYSE:MO) generated total returns of nearly 130% and 190% during the same period. Should investors abandon this industry laggard, or give it another chance to catch up to its peers over the next few years?

A young man smokes a cigarette.

Image source: Getty Images.

The world's top tobacco company

British American Tobacco surpassed Philip Morris International as the world's largest publicly traded tobacco company by annual revenue after its takeover of Reynolds American in 2017. That takeover also made it the second-largest tobacco company in America after Altria (NYSE:MO).

It also made British American Tobacco the only major tobacco company to straddle the U.S. and international markets. Altria, which only operates within the U.S., spun off its international business as PMI back in 2008.

British American Tobacco sells its products in over 180 markets worldwide to more than 150 million consumers. It generates most of its revenue from cigarettes, but it also sells Vuse e-cigarettes, Glo heated tobacco devices, Velo nicotine pouches, and other smokeless products.

How fast is British American Tobacco growing?

British American Tobacco's adjusted revenue and earnings have consistently risen over the past five years.

Fiscal Year

2015

2016

2017

2018

2019

Adjusted Revenue Growth (YOY)

7%

6%

3%

4%

6%

Adjusted Profit Growth (YOY)

4%

4%

4%

4%

7%

Source: British American Tobacco. Constant currency terms. YOY = Year-over-year.

For fiscal 2020, British American Tobacco expects its adjusted revenue to rise "at the high end" of its prior forecast for 1% to 3% growth. It expects its adjusted earnings to also grow by the mid-single digits.

Analysts expect its revenue and earnings to rise 4% and 6%, respectively, this year. Next year, they expect its revenue and earnings to rise 2% and 5%, respectively.

Those growth rates look stable, but British American is still struggling with declining cigarette shipments as smoking rates drop worldwide. But like PMI and Altria, it's raising its prices to offset those declines, cutting costs, and diversifying its business beyond cigarettes.

British American believes it can transition "from cigarettes to non-combustible products over time," and boost its New Categories revenue (mainly from Vuse, Glo, and Velo) from 1.3 billion pounds ($1.8 billion) in 2019 to "at least [5 billion pounds]" ($6.8 billion) in fiscal 2023 or 2024. That would be equal to over a fifth of its top line.

But can it overcome the headwinds?

That outlook sounds promising, but the company still faces intense headwinds. Tighter regulations for e-cigarettes could still throttle Vuse's growth, as they did to Altria's disastrous investment in Juul.

A man holds an e-cigarette and a bundle of cigarettes.

Image source: Getty Images.

Its Glo devices, which heat tobacco sticks instead of burning them, face intense competition from PMI and Altria's iQOS devices. Its Velo nicotine pouches also face competition from similar products like Altria's On, and regulators are still scrutinizing the entire category.

On the bright side, all three of British American's New Category products gained market share against their top rivals throughout 2020. Reynolds' cigarette brands in the U.S., including Natural American Spirit and Newport, also gained ground against Altria's top brands.

It expects its dividend to remain sustainable with a payout ratio of about 65% for the full year. But unlike PMI and Altria, which have raised their dividends every year ever since splitting, British American doesn't consistently raise its dividends. It also won't boost its earnings with buybacks, since it suspended its last buyback program back in 2014.

The bottom line

British American Tobacco's business is still pinned to the secular decline of the cigarette market. It might raise prices or aggressively expand its New Category products to cushion that blow, but it's still in the same sinking boat as Altria, PMI, and other fading cigarette makers.

I recently told investors to avoid Altria, and I believe they should avoid British American Tobacco for similar reasons. Its stock looks cheap and it pays a meaty dividend, but its core business is shrinking, its newer products will generate unpredictable growth, and its total long-term returns are dismal. Simply put, investors should stick with dependable dividend stocks in more stable industries instead.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.