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I find dividends paid by shares to be the best way of making passive income (money made with minimal effort). The only real effort on my part is selecting the shares initially. After that, I need only monitor the stocks’ performance periodically.
A longtime fixture of my passive income portfolio is British American Tobacco (LSE: BATS). It delivers a dividend yield of 5.9% based on 2024’s 235.52p payout and the current £39.63 share price.
It paid a lot more than this before a share price rise in December 2023 pushed the yield lower. This is because a stock’s dividend yield rises when its price falls, assuming the annual payout stays constant.
That said, a rise in one of my passive income stocks’ prices is of little immediate interest to me. I would only benefit if I sold the stock, in which case I would lose its annual dividend payouts.
Consequently, with my passive income stocks, I am more concerned with dividend yield rises than increases in price.
What’s the dividend yield projection?
British American Tobacco has increased its annual dividend since the 2017 completion of its acquisition of Reynolds American. From the 195p it paid in 2018 – its first under the new structure – it has raised these payouts by 21%.
Its current dividend yield of 5.9% far outstrips the present FTSE 100 average of 3.4%. It also compares very favourably to the ‘risk-free rate’ (10-year UK government bond yield) of 4.6%.
Its outperformance of this latter benchmark is important for me. This is because I want compensation for investing in stocks, which are not risk-free.
Looking ahead, consensus analysts’ forecasts are that it will raise its 2025 dividend to 245.7p. This is projected to increase again in 2026 (to 250.3p) and in 2027 (to 258.7p).
These would generate respective dividend yields on the current share price of 6.2%, 6.3%, and 6.5%.
A risk here is that the high degree of competition in its sector could reduce its earnings growth. It is precisely this that ultimately drives any firm’s dividends (and share price) over time.
However, analysts forecast that British American Tobacco’s earnings will grow by 15.8% a year to end-2027.
How much passive income can it generate?
Investors considering a £10,000 investment would see £650 of first-year dividends on the forecast 6.5% yield.
Over 10 years on the same basis this would rise to £6,500 and after 30 it would jump to £19,500.
As good as this looks, it could be a whole lot better, if ‘dividend compounding’ were used. This is a standard investment practice wherein the dividends are simply reinvested back into the stock.
By doing this, the dividends after 10 years would be £9,122 rather than £6,500. And after 30 years they would be £59,918 not £19,500.
Including the initial £10,000 investment, the total value of the British American Tobacco holding would be £69,918 by then. And that would be paying £4,545 a year in passive income from dividends by that point.
Consequently, I will buy more of the stock very soon and think it is well worth other investors’ consideration.
