Investing in consistently profitable businesses with a track record of prioritizing shareholders is a winning investment philosophy. This is because such companies have both the ability and desire to reward shareholders with steady dividends.
British American Tobacco (BTI -0.51%) is one such company that appears to fit within these parameters. But should income investors buy the stock at the present $33 share price? Let's dig into British American Tobacco's fundamentals and valuation to make a judgment.
British American Tobacco's powerhouse portfolio
Years ago, British American Tobacco had an insightful realization: The tobacco industry would be radically transformed by a shift in consumer preferences away from cigarettes and toward products that are perceived to be less detrimental to health. This is why, beginning in 2013, the company launched Vuse, its first and now global leader in the vapor product category. Along with the launch of its Glo heated tobacco brand in 2016 and nicotine pouch brand called Velo in 2019, this has positioned British American Tobacco as a leader in the thriving noncombustible tobacco space.
In the span of just a decade, the company's noncombustible user base has exploded from nothing to over 23 million as of March 31. In just the first quarter, British American Tobacco added another 900,000 noncombustible users, putting the company well on track to reach its goal of 50 million users by 2030.
As the tobacco giant continues to build out the scale of its noncombustible portfolio, it expects to achieve profitability within this portfolio as soon as 2024. And as the company's mix of noncombustible revenue to total revenue expands from a base of approximately 15% as of 2022, this should fuel remarkable earnings growth in the years ahead.
That is why analysts think that British American Tobacco's earnings will compound by an average of 11.8% each year for the next five years. Putting this into perspective, that is superior to the tobacco industry average annual earnings growth forecast of 7.5% for that duration.
Image source: Getty Images.
The payout can be trusted
At first glance, British American Tobacco's 8.3% dividend yield would appear to be a prime example of a yield trap compared to the S&P 500 index's modest 1.6% yield. But this simply isn't the case for two reasons.
First, it is projected that British American Tobacco's dividend payout ratio will come in at just 55% for the next 12 months. Put up against respective forward dividend payout ratios of 72% and 74% for the likes of Altria Group and Philip Morris International, this makes British American Tobacco's payout quite safe.
Then there's also the fact that the company's earnings are poised to continue growing. This will help to further improve British American Tobacco's dividend coverage.
Its valuation provides ample downside protection
British American Tobacco is obscenely undervalued versus its peers, which is great for investors looking to start positions in the stock now. But it is worth noting that this has come at the cost of underwhelming investment results in recent years for existing shareholders.
The good news moving forward is that British American Tobacco's forward price-to-earnings (P/E) ratio of 7 is well below the tobacco industry average forward P/E ratio of 11.8. This significant discount to industry competitors should protect shareholders from further valuation multiple contraction in the years to come, which makes the stock a buy for yield-oriented investors.
