With the FTSE 100 having dropped roughly 200 points (3.4%) since last Friday, it’s not been a great week for UK shareholders. Likewise, the index has slipped around 265 points (4.5%) over the past month. It’s been a lousy year for the Footsie, having collapsed by 2,000 points (26.4%). But enough of the past. I think the way to benefit from these continued declines in the future is to keep buying cheap shares in solid businesses.
These two cheap shares are smoking
I’m here to discuss two tobacco stocks. As a smoker for around a third of a century, I know how unpleasant, unhealthy and expensive this addictive habit can be. As an investor, I also know that tobacco shares are absolutely out of the question for ethical investors. Yet tobacco stocks are popular with income-fund managers and value investors looking to buy cheap shares for their reliable returns.
Cheap stock #1: British American Tobacco
My first low-priced stock is the Goliath of the two: British American Tobacco (LSE: BATS). At its current share price of £24.70, BATS has a market value of £57.7bn, so it’s one of the largest members of the FTSE 100 by size.
What’s more, thanks to its reliable earnings and global scale, BATS has risen up the ranks to become the #2 dividend payer in the entire FTSE 100. Yet the BATS share price has taken a beating in 2020, pushing it deeper into the ‘cheap shares’ dustbin. At their 52-week high on 15 January, BATS shares closed at £35.07, so they are over £10 cheaper today. Yet cigarette sales have held up well during the pandemic.
The obvious attractions of BATS are its lowly rated earnings and steadily rising quarterly dividends. At today’s price, BATS shares trade on price-to-earnings ratio of 9.2, for an earnings yield of 10.9%. Based on four quarterly cash dividends of 52.6p per share, BATS shares offer a mighty 8.5% dividend yield. As a value investor, BATS ticks my boxes, which is why I would buy and hold its cheap shares (preferably inside an ISA) today.
Cheap stock #2: Imperial Brands
Compared to BATS, Imperial Brands (LSE: IMB) is a relative tiddler, weighing in at a market cap of £12bn. Yet as an investment, Imperial shares offer similarly attractive fundamentals as those of its larger counterpart. The maker of Davidoff, Gauloises and JPS cigarettes produces reliable recurring earnings and strong cash flows that translate into bumper dividends.
However, as with BATS, Imperial’s stock has also been dumped in the bargain bin of cheap shares. On Thursday, Imperial shares closed at 1227.5p, down 30.2% in 12 months. Furthermore, Imperial shares today are almost 850p (40.8%) below their 2020 high of 2,072p, hit on 17 January.
One reason for Imperial shares’ decline is the company’s decision earlier this year to cut its interim dividends by a third (to 20.85p a share, from 31.28p). Yet based on a one-third cut to the previous yearly dividend of 206.57p, these cheap shares offer a forward dividend yield of 11.2% a year. That’s more than enough income to compensate for short-term volatility and/or declines, which is why I would also buy and hold this tobacco stock today!
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Cliffdarcy has no position in any of the shares mentioned. The Motley Fool UK has recommended Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2020