Here’s a dirt-cheap FTSE 100 stock with 8.5% dividend yield!

Dividend investors are spoilt for choice these days. As both the performance and prospects of companies improve, dividends are rising. So how do I select the best FTSE 100 stocks from which to earn a passive income for the long term?

British American Tobacco sees share price fall

I like to look carefully at various facets of a stock before making an assessment, like in the case of  British American Tobacco (LSE: BATS). The Dunhill cigarettes manufacturer might be well-known but its popularity is on the decline as tobacco increasingly becomes a no-go. 

At the same time, smoking alternatives are taking their sweet time to become as widely consumed. It does not help that health risks have been flagged for these products as well. Lack of visibility on British American Tobacco’s future growth path could be one of the reasons why the company’s share price has been on a steady downward trend. Over the past five years, it has almost halved. As a result its price-to-earnings (P/E) ratio is at sub-10 times, making it dirt-cheap compared to the 20 times ratio for the FTSE 100 as a whole. 

Tempting yield for the FTSE 100 stock

There is no denying that British American Tobacco’s 8.5% dividend yield is still tempting, though. But this could be because of the fall in share price. The dividend yield is the dividend amount expressed as a percentage of the share price. So, the lower the price drops the higher the yield becomes. This does explain the company’s high yield. To be fair though, British American Tobacco has also increased its dividend levels over time. Since 2016, these have risen by some 27%. 

Is the dividend yield good enough?

But the rise is not significant enough for me to make the stock a compelling long-term investment. This is because the 8.5% dividend yield is in terms of today’s share price. If I had bought the stock five years ago, however, I would receive a yield of 4.7% today because at that time the share price was higher. If this trend continues to play out, I would end up with a stock that is eroding my capital and give me relatively middling dividend yields. 

So why would I buy it when there are plenty of options to buy stocks that can give me these yields and also some capital gains? Some examples of such stocks include FTSE 100 utilities. 

What I’d do

There is of course a chance that the future could look better for the British American Tobacco share price. It is still not back to its pre-pandemic levels. There could be rapid growth in its tobacco alternative products as well. And it is still very much a profitable company that can keep its dividends growing. 

All things considered though, I am inclined to wait and watch how things unfold for it rather than buy it. 

Manika Premsingh has no position in any of the shares mentioned. The Motley Fool UK has recommended British American Tobacco. 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.