Caution Advised for Investors in British American Tobacco’s High Yield

British American Tobacco (NYSE: BTI), a leading player in the global cigarette market, belongs to the consumer staples sector. Cigarette consumers consistently purchase their products, often shielding such companies from economic fluctuations. This positioning enhances the stock’s notably high 7.5% dividend yield, which may appeal to investors.

However, investors should exercise caution. Below are three reasons to reassess an investment in British American Tobacco.

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1. Challenges Unique to British American Tobacco

The primary concern regarding British American Tobacco’s future is rooted in its flagship product, cigarettes, which generate around 80% of its revenue. Such a heavy reliance on one product can pose significant risks for investors.

Image source: Getty Images.

Sales volumes of cigarettes at British American Tobacco have been declining for several years. In 2024, cigarette volumes fell by 5%. The previous two years saw declines of 5.3% in 2023 and 5.1% in 2022. Such persistent decreases reveal a lack of growth. In most other consumer staples companies, investors would likely seek out alternatives under similar circumstances.

Despite these troubling trends, British American Tobacco’s substantial dividend yield often encourages some investors to overlook the company’s deteriorating fundamental performance.

2. Dividends Supported by Price Increases

British American Tobacco’s cigarette business faces similar challenges as other tobacco producers, making it not an isolated case of underperformance. Acknowledging the issues, the company has invested in alternative ventures, aiming to eventually transition away from its reliance on cigarette sales.

In the interim, British American Tobacco has capitalized on the steady demand for cigarettes to implement price hikes. These increases mitigate the impact of volume declines, allowing the company to sustain its considerable dividend payments. Despite the ongoing challenges, the firm has continued raising dividends to attract income-focused investors.

However, should the company reach a point where further price increases worsen its volume losses, the attractiveness of British American Tobacco as an income-generating stock may quickly diminish.

3. High Yield May Not Equate to Value

Another aspect to consider regarding British American Tobacco’s high dividend yield is that it can mislead investors into thinking the stock is undervalued. While consumer staples are typically viewed as necessities, cigarettes do not fall into that category.

Data by YCharts.

When assessing traditional valuation metrics such as price-to-sales and price-to-book ratios, British American Tobacco appears overvalued. These metrics are generally more stable than earnings figures over time. Additionally, in 2023, the company incurred a significant one-time charge related to changes in accounting for its U.S. cigarette operations. Management indicated that this business is expected to lose value over the next three decades.

Therefore, British American Tobacco seems expensive based on essential valuation metrics, and current earnings trends do not provide useful insights due to the company’s acknowledgment of its core business weaknesses. Investors in search of high yields should consider these risks carefully when buying shares of British American Tobacco.

Assessing Long-Term Risks

In the short term, it is probable that British American Tobacco can maintain price increases to counteract declining volumes. There is potential that it could establish alternative revenue streams to replace cigarettes effectively. However, the possibility of such an outcome raises the question: is it a risk worth taking, especially for those relying on dividends for income?

Given the challenges related to core business decline, the reliance on price increases to support dividends, and concerning valuation metrics, British American Tobacco may not be suitable for long-term dividend investors.

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Reuben Gregg Brewer has no positions in any of the stocks mentioned. The Motley Fool recommends British American Tobacco P.l.c. and suggests 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.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.