Could This Undervalued Stock Make You a Millionaire 1 Day?
British American Tobacco (NYSE: BTI) has a massive 9.9% dividend yield. If it can sustain that dividend, investors will basically get the average return of the market over time from dividends alone. If the stock price goes up, all of that gain would be gravy. That sounds like a recipe for long-term investment success. But read this before you jump in thinking British American Tobacco is set to make you a millionaire.
Getting British American Tobacco's bad news out first
The problem with British American Tobacco is that the main product it sells is cigarettes. Demand for cigarettes has been in decline for years. For example, in 2018 the company produced around 700 billion cigarettes. In 2023 the figure was just 555 billion. So in just five years the company's production of cigarettes fell by roughly 21%, which is a hugely troubling figure for a consumer staples business.
Notably, in 2023 British American Tobacco changed the way it accounted for its U.S. cigarette operations. It shifted from expecting them to have value in perpetuity to expecting them to end up worthless within 30 years. That's a complex accounting issue that required an immediate write-down and necessitates higher ongoing depreciation expenses, which will be an ongoing drag on profits. But the real statement here is that the cigarette maker sees pretty clearly that its core business is in terminal decline, at least in the United States.
Cigarettes are the company's bread and butter right now. The revenue and profits from this segment of the company are what's supporting the huge dividend yield. The company has so far been able to offset volume declines with price increases, like most of its peers, but that's a troubled path to walk down. At some point, higher prices are likely to start exacerbating the decline more than they are helping the bottom line. This little bit of backstory should be enough to worry more conservative investors, particularly if they are trying to build a dividend portfolio to live off of in retirement.
British American Tobacco has time, but how much?
To be fair, there doesn't appear to be an imminent threat to the dividend, given that the cigarette business is still throwing off lots of cash. So it would be understandable that income-focused investors would want to dig into the story here. And then there's the potential share price upside if the company actually manages to find new products to sell, effectively offsetting the decline in cigarettes.
British American Tobacco is, in fact, doing just that. And its so-called "new categories" are performing even better than expected. The new categories group achieved category level profitability in 2023, two years ahead of schedule. Products in this group include vapes, heated tobacco, and oral offerings. Although not every new category is doing great, the overall effort to shift away from cigarettes is clearly going reasonably well. The company's goal is to generate 50% of its top line from noncombustible products by 2035, roughly 11 years from now.
Given the solid progress it is making as it shifts away from cigarettes, there's good reason to believe it can achieve its desired result. And if it does, the stock would likely be revalued in a positive light by investors. In other words, there's upside potential here, noting that the stock is down around 60% from the highs it reached in 2017. Add in the huge dividend yield and there could be material returns ahead... if the company succeeds in shifting its business away from cigarettes.
British American Tobacco is high-risk/high-reward
At the end of the day, British American Tobacco's efforts to update its business for a future without cigarettes could, indeed, lead to millionaire-maker gains in the stock (particularly when you add in the fat dividend yield). But there's a long way to go before the company is anywhere near the point where it can say it has achieved its diversification goals. And there are a lot of things that could still go wrong along the way. So, yes, British American Tobacco could help make investors rich, but an investment here comes with a lot of risk. Only more aggressive types should be looking at it. And if you buy it, you probably won't want to bet the house on it, just in case it falls short of its goals.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco P.l.c. and recommends the following options: long January 2026 $40 calls on British American Tobacco and short January 2026 $40 puts on British American Tobacco. The Motley Fool has a disclosure policy.
Could This Undervalued Stock Make You a Millionaire 1 Day? was originally published by The Motley Fool
