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Investing in stocks to generate a second income from dividends has never been easier than today. And if I do this within a stocks and Shares ISA, I don't have to worry about paying tax on my returns.
Even better for UK investors, the London Stock Exchange is loaded with ultra-high-yield dividend stocks right now. This is because many stock prices have been under pressure due to higher interest rates, and this has pushed up yields.
A notable example is British American Tobacco (LSE: BATS). The share price has fallen around 18% over the past year, meaning the expected dividend yield for 2024 is a whopping 10.1%.
If I had £10k sitting idle in an ISA today, I'd consider this FTSE 100 tobacco stock for passive income.
Please note that tax treatment depends on each client's individual circumstances and may be subject to change in the future. The content of this article is provided for informational purposes only. It is not intended to be, nor does it constitute, any type of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.
Portfolio Options
Now, although I recently invested in the stock, I had my reservations. As The Motley Fool Co-founder David Gardner often says: “Make your portfolio reflect your best vision for our future.”
Is smoking really my best vision for that future? I mean, even British American Tobacco itself is officially committed to “building a smoke-free world“. But isn't that a bit like kfc away from the chickens?
It seems clear that there is an above average risk, and that worried me.
Of course, it is up to each person to decide how they invest. Some investors won't put their money in oil or defense stocks. Others wouldn't touch the game's actions with a 10-foot pole. And that's fine.
So why have I chosen to invest?
Three reasons
First, the stock appears to offer incredible trading value at just 6.3 times forecast earnings.
It is true that there are risks to earnings associated with the long-term decline in the number of smokers globally. But I can't help but feel that this is included in the valuation (and then some). There seems to be a margin of safety.
For context, Philip Morris International The stock trades at 15.2 times forecast earnings and has a dividend yield of 5.7%.
If British American Tobacco ever decides to move its primary listing to New York, I think the shares would appreciate significantly in anticipation of a potential higher valuation. We have seen examples of this type in recent times and, in a sense, they are almost self-fulfilling.
Second, the high-yield dividend appears sustainable. The payment for fiscal 2024 is covered 1.53 times expected earnings. In other words, the expected dividend per share (238p) is covered by the expected earnings per share (365p).
So while no dividend is ever guaranteed, it seems likely that it will be paid.
Lastly, the company's New Categories division, which houses vaping brands like Vusebecame profitable in 2023. That was two years ahead of the company's original goal, which is a positive sign for the future.
Passive income
As mentioned, each share is expected to pay a dividend of 238p for this financial year. In 2025, brokers predict that figure will rise to 248 pence per share.
Of course, analysts' expectations are not always met. And a quarterly payment has already been arranged (to be paid on May 2).
But assuming these forecasts prove correct, this means that £10,000 worth of shares bought today could generate around £1,800 in passive income over the next few years.
Then potentially more in subsequent years, depending on business performance.
