Passive income is money that keeps rolling in with minimal ongoing effort, as with dividends paid by shares. And British American Tobacco (LSE: BATS) seems built for exactly that to me.
The huge cash flows it generates support one of the most reliably high dividend yields in the FTSE 100. That combination alone makes it hard for me to ignore.
I already have holdings in the stock, but am wondering whether I should buy more.
Is now a good time?
Some investors may be deterred from buying the stock for fear they could be hit by share price losses, following huge gains recently.
But price and value are not the same thing. Price is whatever the market pays at any point, while value reflects underlying business fundamentals.
I ran a discounted cash flow (DCF) analysis to ascertain whether there is value left in this stock. The DCF projects future cash flows and discounts them to the present.
The more uncertain those forecasts are, the higher the return investors demand, increasing the discount applied. Analysts’ assumptions can vary, making outcomes more bullish or bearish. But using my own inputs — including an 8.7% discount rate — British American Tobacco appears 31% undervalued at its current £49.24 price.
That suggests a ‘fair value’ of £71.36 — significantly higher than the present level. If markets continue to converge toward fair value and my modelling is correct, this could be a great time to buy more based on possible share price gains as well as dividend income.
How much passive income could I make?
Analysts forecast British American Tobacco’s dividend yield will be 5.4% this year, 5.6% next year, and 5.8% in 2028. Another £20,000 invested now would buy me 406 shares.
These could generate £15,671 in dividends over 10 years and £93,470 over 30 years. It assumes the forecast 5.8% as an average but this could go up or down. It also factors in the dividends being reinvested to fully utilise the turbocharging effect of ‘dividend compounding’.
After 30 years on this basis, the holding’s total value would be £113,470. And this would deliver an annual income at that point of £6,581! Remember though, a 30-year future for a tobacco stock is not guaranteed.
How reliable do the dividends look?
The key support for sustained high dividends is profit growth over time.
A risk for British American Tobacco is rising nicotine product sales not compensating for falling cigarette volumes. Another is increased regulatory pressure on packaging, marketing or nicotine levels denting cash flows.
That said, analysts project the firm’s profits will keep growing at an average of 4.1% a year until 2028 at least.
In its 2025 annual results, the company forecast 4%–6% adjusted operating profit growth in 2026, and 5%–8% adjusted diluted earnings per share growth.
My investment view
British American Tobacco offers a very dependable dividend streams, in my view. It is backed by strong cash generation and steady profit growth. Its valuation also looks compelling to me, even after its share price rise.
For passive income investors, that combination of high yield, resilience and undervaluation makes it worth serious attention. And I will be buying more of the stock very shortly.
In addition, other high-yielding underpriced stocks in different sectors have recently caught my eye.
Simon Watkins owns shares in British American Tobacco.
