My funding focus in recent times has been on maximising passive revenue from dividends paid by shares. That is one of the simplest ways I’ve discovered to become profitable with minimal effort – the definition of passive revenue.

British American Tobacco (LSE: BATS) has lengthy been one among my core holdings for attaining this. It has all three qualities that I search for in such a inventory — a excessive yield, sturdy earnings development, and market undervaluation, in my opinion.

A excessive yield

In 2023, it paid a complete dividend of 230.89p, yielding 8% on its present £28.76 share price.

This yr, it lifted its three interim dividends by 2%. If the ultimate interim dividend elevated by the identical quantity the whole payout can be 235.2p. This might yield 8.2% in comparison with the common 3.6% of the FTSE 100.

Analysts forecast dividends of 246.5p in 2025 and 257.9p in 2026, giving respective returns of 8.6% and 9%.

Sturdy earnings development

Finally, earnings development drives a agency’s dividend and share price. A threat to this for British American Tobacco is any delay in its swap from tobacco merchandise to nicotine replacements, I feel. This might give opponents doing the identical factor a market benefit.

Nonetheless, because it stands, analysts forecast that its earnings will improve by a surprising 44% every year to end-2026.

Share undervaluation

I’ve no intention of promoting the shares, offered they preserve producing a excessive yield. Nonetheless, ought to I ever want to take action, I’d clearly somewhat not make a loss on what I paid for them.

To minimise the prospect of this occurring, I solely purchase shares which are undervalued on two broad measures. First, towards the shares of competitor companies, based mostly on key ratios I take advantage of. And second, on the price indicated through the use of future money circulation forecasts for the agency.

On the previous, British American Tobacco is undervalued on each the price-to-book and price-to-sales ratios.

On the latter, a discounted money circulation analysis reveals the inventory is 57% undervalued at £28.76. Subsequently, a good worth can be £66.88, though it’d go decrease or increased, given market unpredictability.

How a lot passive revenue might be made?

£17,000 (the common UK financial savings account quantity) would purchase me 591 shares within the agency now. And if I at the moment had the prepared funds obtainable to do that, I’d do it proper now.

With an 8% yield, these would pay £1,360 in dividends within the first yr. This might rise to £13,600 after 10 years on the identical foundation and to £40,800 after 30 years.

Nonetheless, through the use of the dividends to purchase extra British American Tobacco shares, these payouts would rise enormously.

Doing this (‘dividend compounding’) on an 8% yield would generate £20,734 of dividends after 10 years, not £13,600. And after 30 years, the dividends paid would rise to £168,907 as an alternative of £40,800.

The entire worth of the holding (including within the £17,000 preliminary funding) can be £185,907. Consequently, if the inventory have been nonetheless yielding 8% (it might be decrease or increased), it will generate £14,873 a yr in passive revenue by then.

Inflation would scale back the shopping for energy of the cash over the interval. Nonetheless, it reveals a small funding can generate huge passive revenue, particularly when dividends are compounded.