FTSE 100 tobacco and nicotine alternative merchandise producer British American Tobacco (LSE: BATS) is buying and selling round its 12-month excessive.

As yields fall when share costs rise, the payout on the inventory has fallen. Nonetheless, it’s nonetheless giving a return of 8.3%. This is without doubt one of the highest payouts within the FTSE 100, which at present has a mean yield of three.6%.

Such a excessive return can generate a really important passive revenue from the dividends paid.

Payouts with no dividend reinvestment

The typical UK financial savings quantity is £11,000. This invested in British American Tobacco would pay £913 in dividends this 12 months.

So, over 10 years if the yield averaged the identical the whole return can be £9,130 so as to add to the £11,000 preliminary funding. This may pay a passive revenue of £1,671 every year.

After 30 years, the whole funding can be valued at £38,390, given the identical common yield. It could generate £3,186 a 12 months in dividend funds.

This can be a lot higher than can be made in a daily UK financial savings account. However it’s nowhere close to the doubtless life-enhancing passive revenue that may be made by reinvesting these dividends again into British American Tobacco shares.

It’s the similar concept as compound curiosity in a checking account, however fairly than curiosity being reinvested, dividends are.

Supercharging returns by means of compounding

Doing this is able to make an additional £14,155 after 10 years as an alternative of £9,130. Added to the preliminary £11,000 funding, this is able to pay £2,088 a 12 months in comparison with £1,671.

After 30 years, the whole funding within the agency can be price £131,542 fairly than £38,390. It could pay £10,918 every year in passive revenue, not £3,186!

Whereas yields fall when share costs rise, they’ll additionally improve if annual dividend funds are boosted.

British American Tobacco did simply this in its H1 2024 outcomes – including 2% to the Q2 fee. It did the identical for the Q1 fee too.

Factoring this into future funds, analysts anticipate the shares to yield 9% by end-2025 and 9.5% by end-2026.

Are the shares undervalued too?

In choosing shares for my passive income-generating portfolio I additionally look to their relative worth.

A inventory that’s undervalued towards its friends is much less prone to drop a good distance for an prolonged interval. This implies there may be much less likelihood of my dividend returns being worn out.

It additionally will increase the possibility of my having the ability to make some cash on an increase within the share price over time.

British American Tobacco at present trades on the important thing price-to-earnings ratio (P/E) at simply 7.5. That is very low-cost in comparison with the common 13.8 P/E of its friends.

In reality, a reduced money move analysis exhibits the inventory to be 57% undervalued at its current price of £27.90. Subsequently, a good worth can be £64.88, though it might go decrease or increased than that.

A threat within the shares is that the agency loses market share to its rivals for some cause. One other is any litigation from alleged unwell results of its merchandise.

Nonetheless, consensus analysts’ estimates are that its earnings will improve by 52.1% every year to the tip of 2026.

I already personal the inventory but when I didn’t I’d purchase it immediately for its excessive yield, undervaluation, and progress prospects.