A forecast dividend yield of 6.4% and 44% undervalued, is it time for me to buy more of this FTSE powerhouse?

I originally bought the FTSE 100’s Imperial Brands (LSE: IMB) as a high-yielding dividend stock some years ago. At that point it in 2020, it was delivering a yield of well over 10%.

That said, dividend yields move in the opposite direction to share price. And since then, the stock has been on a bullish run – rising 135% since mid-October that year.

Part of this rise has come from investor positivity about the company’s ongoing strategic business shift. This is to ‘next generation products’ – mainly nicotine substitutes – away from tobacco.

Another part came from its very high dividend allure, and a further factor was its rolling programme of share buybacks. These tend to support share price gains, and since 2020 it has committed to £4.8bn of them, with around £3.35bn completed so far.

To be honest, I prefer stocks I bought for their very high dividend yields to keep delivering those. After all, a share price gain is only useful if I sell the stock.

So I re-examined the stock to see where the share price and the dividend yield might head. If the price is not going much higher and the dividend yield remains the same – around 4.9% — I might as well sell it. I can get much higher dividend yields from other stocks.

Further share price gains?

Asset prices tend to converge to their ‘fair value’ over time, in my experience. This includes 35+years as a private investor and several years as a senior investment bank trader before that. Fair value reflects underlying business fundamentals, while price is merely whatever the market will pay at any point.

The discounted cash flow valuation method is the optimal way I have found to ascertain a stock’s fair value. This pinpoints the price at which any share should trade, derived from cash flow forecasts for the underlying business.

In Imperial Brands’ case, it shows the stock is 44% undervalued at its current £31.01 price. Therefore, its fair value is £55.38.

A risk to its valuation is any failure in implementing its switch towards nicotine replacement products, which could hurt earnings. But as it stands, the numbers underline that there is a lot of scope for further share price gains.

A rising dividend yield?

The current 4.9% dividend yield is based on the most recent total payout of 153.42p. Although less than its glory days of a few years ago, it is still greater than the FTSE 100 average of 3.3%.

The good news for me is that analysts forecast its dividends will increase to 168.8p in 2026, 177p in 2027, and 199.6p in 2028. These would generate respective yields of 5.4%, 5.6%, and 6.4%.

So another £10,000 investment from me would make £8,933 in dividends after 10 years at 6.4%. It also includes me reinvesting the dividends back into the stock (dividend compounding). Over 30 years on the same basis, this would increase to £57,862.

At that point, the total Imperial Brands holding would be worth £67,862. And that would be paying me £4,343 every year in dividend income.

Given this dividend yield outlook, and to a lesser degree the potential for share price gains, I will buy more of the stock very soon.

The post A forecast dividend yield of 6.4% and 44% undervalued, is it time for me to buy more of this FTSE powerhouse? appeared first on The Motley Fool UK.

More reading

• British American Tobacco and Imperial Brands are both high-yield shares. Here’s the one I prefer!
• How much do you need in a Stocks and Shares ISA to aim for a £1,000 monthly income?

Simon Watkins has positions in Imperial Brands Plc. The Motley Fool UK has recommended Imperial Brands Plc. 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.

See author's posts