British American Tobacco: This 8.5% Yielding Dividend Aristocrat Is Set To Soar And Too Cheap To Ignore

Summary

  • Today's 26% overvalued market means future returns for stocks are likely to be disappointing.
  • But it's always a market of stocks, not a stock market, and incredible high-yield aristocrat bargains are always available if you know where to look.
  • BTI is a 50% undervalued 8.5% yielding global aristocrat trading at 7.2x forward earnings, and pricing in -2.6% CAGR long-term growth. It's the most attractive valuation in 20 years.
  • Analysts actually expect its smoke-free future plans (which are going better than expected) to deliver 3% to 5% CAGR growth while management thinks buybacks can boost that to 7% to 9%.
  • Over the next five years, analysts think BTI could triple and deliver almost 13% CAGR long-term returns for decades. The last time BTI was this undervalued, it delivered 1,800% total returns over the next 15 years.
  • Looking for a portfolio of ideas like this one? Members of The Dividend Kings get exclusive access to our model portfolio. Learn More »

stack of dollars spread out

Andrey Maximenko/iStock via Getty Images

In the last decade, we've seen one of the best bull markets in history.

Naturally, such incredible returns mean valuations have gotten a bit stretched, to say the least.

JPMorgan (JPM) estimates that the S&P is now 26% historically overvalued, and likely to deliver rather disappointing returns in the coming years.

S&P 500 2023 Consensus Total Return Potential

(Source: FAST Graphs, FactSet Research)

S&P 500 2026 Consensus Total Return Potential

(Source: FAST Graphs, FactSet Research)

The market is expected to deliver just 1/3 the returns investors have enjoyed over the last 10 years.

Dividend Aristocrats are expected to deliver about 6.4% CAGR returns over the next five years, which is half the returns of the last decade.

But thankfully, it's always a market of stocks, not a stock market.

Just a few days ago, 91% of the S&P 500 was in a correction, and the majority of tech stocks were in a bear market.

In other words, no matter your investment goals, maximum safety yield, maximum safety and quality, growth and total returns, foreign dividend stocks, monthly dividend stocks, low volatility stocks, strong ESG stocks, etc., it doesn't matter.

Something wonderful is always on sale if you know where to look.

Today I want to explain the four reasons that British American Tobacco (NYSE:BTI) is one of the best Buffett-style fat pitches on Wall Street.

In fact, this 8.5% yielding global dividend aristocrat is set to soar, and too cheap to ignore.

That's why I've bought it 228 times so far, totaling $192,000 across all three of my retirement portfolios.

When it's raining gold, reach for a bucket, not a thimble...

Wait for a fat pitch, and then swing for the fences." - Warren Buffett

Today BTI might be just what your diversified and prudently risk-managed portfolio needs to help you achieve the rich retirement of your dreams.

Reason 1: The Best Buying Opportunity In 20 Years

BTI is once more in a correction, one that's part of the longest bear market in 35 years.

However, remember that valuations always matter, and they matter a lot.

When BTI began its current bear market it was 50% historically overvalued, as low-interest rates caused a bubble in high-yield blue-chips.

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(Source: FAST Graphs, FactSet Research)

BTI went from 50% overvalued, to 50% undervalued in less than two years, and its valuation remains the most attractive in two decades.

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(Source: FAST Graphs, FactSet Research)

Rule number one: most things will prove to be cyclical.

Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one." - Howard Marks

BTI has had plenty of corrections and bear markets in the last 35 years, all blue-chips have.

BTI Peak Declines Since 1986

(Source: Portfolio Visualizer)

But the last time BTI was this undervalued it delivered 25% CAGR total returns for the next 15 years. That's 19x your money in a high-yield aristocrat bargain hiding in plain sight.

Investment Strategy Yield LT Consensus Growth

LT Consensus Total Return Potential

British American Tobacco 8.5% 4.2% 12.7%
Safe Midstream 6.2% 6.2% 12.4%
Safe Midstream + Growth 3.3% 8.5% 11.8%
REITs 3.0% 6.9% 9.9%
High-Yield 2.8% 11.2% 14.0%
Dividend Aristocrats 2.4% 8.9% 11.3%
Value 2.1% 11.9% 14.0%
60/40 Retirement Portfolio 1.8% 5.1% 6.9%
REITs + Growth 1.8% 8.9% 10.6%
High-Yield + Growth 1.7% 11.0% 12.7%
S&P 500 1.5% 8.5% 10.0%
Dividend Aristocrats + Growth 1.4% 12.3% 13.7%
Nasdaq (Growth) 0.5% 10.9% 11.4%

(Source: Morningstar, FactSet Research)

Today analysts expect BTI to deliver very attractive long-term returns, over the decades, of nearly 13% and management says it can deliver 15.5% to 17.5% CAGR.

Be greedy when others are fearful." - Warren Buffett

However, John Templeton and Howard Marks, two of the greatest investors in history, did say that "20% of the time, this time really is different".

So let's take a look at why this time isn't likely different for BTI, and anyone buying this high-yield aristocrat today is likely to be very happy with the results in the coming years and decades.

Reason 2: The Best High-Yield Global Aristocrat You Can Buy Today

The Dividend King's overall quality scores are based on a 207 point model that includes

  • dividend safety

  • balance sheet strength

  • short and long-term bankruptcy risk

  • accounting and corporate fraud risk

  • profitability and business model

  • growth consensus estimates

  • cost of capital

  • long-term risk-management scores from MSCI, Morningstar, FactSet, S&P, Reuters/Refinitiv and JUST Capital

  • management quality

  • dividend friendly corporate culture/income dependability

  • long-term total returns (a Ben Graham sign of quality)

  • analyst consensus long-term return potential

It actually includes over 1,000 metrics if you count everything factored in by 12 rating agencies we use to assess fundamental risk.

  • credit and risk management ratings make up 38% of the DK safety and quality model

  • dividend/balance sheet/risk ratings make up 77% of the DK safety and quality model

How do we know that our safety and quality model works well?

During the two worst recessions in 75 years, our safety model predicted 87% of blue-chip dividend cuts during the ultimate baptism by fire for any dividend safety model.

BTI Fundamentals: Impeccable Safety, Quality, And Long-Term Risk Management Retirees Can Trust

Dividend Safety score: 82% - 5/5- very safe (0.5% average recession cut risk, 2.0% pandemic level recession cut risk)

Dependability score: 86% - 5/5 exceptional dependability

Quality score: 82% - 13/13 Ultra SWAN (Sleep Well At Night) - global aristocrat

Long-term risk management consensus: 82nd industry percentile - very good

2021 average fair value: $69.28

2022 average fair value: $68.40

12-month blended forward harmonic average fair value: $68.61

Current Price: $34.65

Discount To Fair Value/Margin of safety: 49.49%

DK rating: potential ultra-value/anti-bubble/Buffett-style "fat pitch"

What makes BTI such a wonderful company?

Let's start with income dependability. Ben Graham considered 20 years without a dividend cut a sign of quality and 20+ years of conservative dividend growth a sign of excellence.

BTI Is A Global Aristocrat (S&P Definition) Based On A 22+ Year Dividend Growth Streak

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(Source: investor presentations)

BTI meets Graham's standard of excellence, and analysts expect that mouth-watering yield to grow steadily every year.

BTI Dividend Consensus Forecast

Year Dividend Consensus EPS/Share Consensus Payout Ratio Retained (Post-Dividend) Earnings Flow Buyback Potential Debt Repayment Potential
2021 $3.03 $4.52 67.0% $3,420 5.93% 5.8%
2022 $3.19 $4.87 65.5% $3,856 6.69% 6.6%
2023 $3.44 $5.28 65.2% $4,223 7.33% 7.4%
2024 $3.60 $5.52 65.2% $4,406 7.65% 7.9%
Total 2021 Through 2024 $13.26 $20.19 65.7% $15,904.35 27.60% 27.17%
Annualized Rate 5.91% 6.89% -0.91% 8.82% 8.82% 10.71%

(Source: FactSet Research Terminal)

85% is the payout ratio safety guideline for tobacco, and BTI's policy is to pay out 65% of earnings as dividends that grow steadily over time.

That's the lowest payout ratio among blue-chip tobacco and potentially will allow BTI to buy back 7% to 8% of its shares annually once it's done deleveraging.

BTI Leverage Consensus Forecast

Year Debt/EBITDA Net Debt/EBITDA (3.0 Or Less Safe According To Credit Rating Agencies)

Interest Coverage (8+ Safe)

2020 3.63 3.37 6.73
2021 3.55 3.17 7.14
2022 (Safe Balance Sheet) 3.30 2.83 8.00
2023 3.04 2.51 9.11
2024 NA 2.13 NA
2025 NA 1.69 NA
Annualized Change -5.65% -12.87% 10.62%

(Source: FactSet Research Terminal)

BTI's balance sheet is expected to achieve safe rating standards in 2022, and according to management, 2021 on an adjusted EBITDA basis.

We remain committed to our 65% dividend payout ratio and dividend growth in sterling terms, continuing to invest in the transformation of the business and building A Better Tomorrow while deleveraging the balance sheet to reach around 3x adjusted net debt to adjusted EBITDA by the year-end.

At that point, we expect increased flexibility for capital allocation." - BTI H1 results press release

In other words, BTI could potentially turn on the buy-back growth jets as early as January.

BTI Credit Ratings

Rating Agency Credit Rating 30-Year Default/Bankruptcy Risk Chance of Losing 100% Of Your Investment 1 In
S&P BBB+ stable 5.00% 20.0
Fitch BBB stable 7.50% 13.3
Moody's Baa2 (BBB equivalent) stable 7.50% 13.3
Consensus BBB stable 6.67% 15.0

(Sources: S&P, Fitch, Moody's)

Rating agencies estimate the long-term potential of losing all your money in BTI at just under 7%.

BTI Balance Sheet Consensus Forecast

Year Total Debt (Millions) Cash Net Debt (Millions) Interest Cost (Millions) EBITDA (Millions) Operating Income (Millions) Interest Costs
2020 $60,916 $4,647 $56,567 $2,340 $16,803 $15,746 3.84%
2021 $58,538 $5,410 $52,327 $2,119 $16,507 $15,138 3.62%
2022 $57,175 $6,704 $49,095 $2,003 $17,325 $16,018 3.50%
2023 $55,586 $8,331 $45,811 $1,864 $18,257 $16,980 3.35%
2024 NA NA $41,213 NA $19,306 $17,643 NA
2025 NA NA $32,991 NA $19,514 $17,797 NA
Annualized Growth -3.01% 21.48% -10.22% -7.30% 3.04% 2.48% -4.43%

(Source: FactSet Research Terminal)

BTI's average borrowings costs are 3.54% and are expected to decline to under 3.4% in the coming years.

Bond Market Has Confidence In BTI's Smoke-Free Future

(Source: FactSet Research Terminal)

The bond market is considered the "smart money" on Wall Street. And the bond market is willing to lend to BTI for 34 years at 4.3%.

This is not a dying company, and the facts clearly prove it.

BTI Profit Margin Consensus Forecast

Year FCF Margin EBITDA Margin EBIT (Operating) Margin Net Margin Return On Capital Expansion

Return On Capital Forecast

2020 29.0% 47.1% 44.1% 29.5% 1.05
2021 29.1% 47.4% 43.5% 29.2% TTM ROC 181.6%
2022 30.4% 47.9% 44.3% 30.2% Latest ROC 186.3%
2023 31.6% 48.3% 44.9% 31.0% 2025 ROC 190.1%
2024 NA 47.7% 43.6% 30.9% 2025 ROC 195.0%
2025 NA 49.9% 45.5% 33.3% Average 192.5%
2026 NA NA NA NA Industry Median 86.6%
Annualized Growth 2.86% 1.18% 0.64% 2.45% BTI/Peers 2.22
Vs S&P 15.00

(Source: FactSet Research Terminal)

BTI is on track to cut 1.5 billion pounds worth of expenses in the next few years, and analysts expect steady growth in margins, just as BTI has achieved for decades.

But after a very rough few years, I understand if you're skeptical, and think BTI is a yield/value trap.

So here's more strong evidence that it's not.

Reason 3: Strong Execution On Its Smoke-Free Future Plans Means Decades Of Steady Dividend Growth Ahead

Metric 2020 Growth 2021 Growth Consensus 2022 Growth Consensus 2023 Growth Consensus

2024 Growth Consensus

Sales 7% -3% 4% 4% 7%
Dividend 9% 2% 5% 8% 5% (25+ Year Growth Streak)
EPS 10% -2% (100% currency-related) 8% 9% 5%
Owner Earnings (Buffett smoothed out FCF) 55% 3% NA NA NA
Operating Cash Flow 9% 28% 7% 10% NA
Free Cash Flow 12% 8% 3% 14% NA
EBITDA 2% 22% 5% 6% 3%
EBIT (operating income) 3% 22% 5% 6% 2%

(Source: FAST Graphs, FactSet Research)

Steady growth in sales, earnings, cash flows, and dividends are proof positive that BTI is NOT a value trap.

In fact, during this current bear market, BTI's earnings and dividends have grown at 7.8% CAGR, and 3.6% CAGR, respectively.

(Source: investor presentation)

Management is guiding for 4% long-term sales growth, and 8% long-term earnings growth.

(Source: September 2021 investor presentation)

This year, when BTI is down slightly in a red hot market, earnings in constant currency are expected to grow about 7%, with sales growth of over 5%.

How does management plan to keep growing when global cigarette volumes are declining?

(Source: September 2021 investor presentation)

By pivoting to a smoke-free future and investing in non-nicotine growth markets like Cannabis.

(Source: September 2021 investor presentation)

BTI's smoke-free future plans are objectively going very well.

(Source: September 2021 investor presentation)

In the first half of 2021, reduced risk product sales soared 50%.

(Source: September 2021 investor presentation)

All of its RRP segments are gaining market share and growing like weeds.

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(Source: September 2021 investor presentation)

Oral nicotine pouches, the safer alternative to chewing tobacco, is growing even faster, at 63%.

BTI's execution of its smoke-free future plans has been very good.

BTI's sales, earnings, cash flows, and dividends are all growing, this is an objective fact, and disproves the bearish thesis that BTI is a value/yield trap headed down forever, possibly to zero.

But here's some more evidence.

(Source: FactSet Research Terminal)

  • growth consensus range 4.0% to 4.2% CAGR

Smoothing for outliers 25% margin of error to the downside, 10% to the upside.

  • 3% to 5% CAGR margin-of-error adjusted growth consensus range
  • 7% to 9% management guidance

(Source: FAST Graphs, FactSet Research)

Management says it can grow BTI's earnings at historical rates, and analysts think 3% to 5%. But for a company priced for -2.6% CAGR growth, it's clear the market is mispricing BTI's risk profile.

Any company that continues to grow steadily is objectively NOT a value trap, but potentially an anti-bubble Buffett-style "fat pitch".

Reason 4: Anti-Bubble Valuation Means Buffett-Like Return Potential From A Blue-Chip Bargain Hiding In Plain Sight

(Source: FAST Graphs, FactSet Research)

For 20 years investors, outside of bear markets and bubbles, have paid 13.5 to 14.5x earnings for BTI. This means a 91% statistical probability that about 13.5 to 14.5x earnings approximates intrinsic value.

And remember that during this time period BTI experienced its worst bear market ever, during the 2000 Master Settlement period.

In other words, back then investors were even more bearish on BTI than they are now. If BTI grows as expected, then it's highly likely that BTI will return to 13.5 to 14.5x earnings historical market-determined fair value.

Metric Historical Fair Value Multiples (10-Years) 2020 2021 2022 2023 2024

12-Month Forward Fair Value

13-Year Median P/S 4.12 $46.14 $45.73 $47.79 $49.85 $53.15
5-Year Average Yield 6.65% $44.51 $44.87 $44.87 $51.73 $54.14
13-Year Median Yield 4.03% $73.45 $74.04 $74.04 $85.36 $89.33
25-year Average Yield 4.29% $69.00 $69.56 $69.56 $80.19 $83.92
Earnings 14.13 $64.96 $63.82 $68.78 $74.65 $78.00
Owner Earnings (Buffett Smoothed Out FCF) 19.13 $115.44 $119.19 NA NA NA
Operating Cash Flow 14.93 $67.48 $86.54 $92.79 $101.82 NA
Free Cash Flow 17.19 $72.86 $78.81 $81.24 $92.97 NA
EBITDA 9.97 $67.90 $82.77 $87.21 $92.82 $95.91
EBIT (operating income) 10.82 $68.66 $83.80 $87.82 $93.04 $94.46
Average $64.88 $69.28 $68.40 $75.58 $74.28 $68.61
Current Price $34.65

Discount To Fair Value

46.59% 49.98% 49.35% 54.16% 53.35% 49.49%

Upside To Fair Value (Not Including Dividends)

87.24% 99.93% 97.42% 118.14% 114.38% 98.00%
2021 EPS 2022 EPS 2021 Weighted EPS 2022 Weighted EPS 12-Month Forward EPS 12-Month Average Fair Value Forward PE

Current Forward PE

$4.52 $4.87 $1.04 $3.75 $4.79 14.3 7.2

BTI is the most undervalued global aristocrat on earth. It could deliver over 100% total returns in the next year, and that would merely be returning to historical fair value.

Here's what investors buying BTI today can reasonably expect.

  • 5-year consensus return potential range: 21% to 24% CAGR

BTI 2023 Consensus Total Return Potential

(Source: FAST Graphs, FactSet Research)

BTI 2026 Consensus Total Return Potential

(Source: FAST Graphs, FactSet Research)

Over the long-term analysts expect:

  • 8.5% yield (vs. 2.3% aristocrats) + 4.2% growth (vs. 8.9% aristocrats) = 12.7% CAGR total return potential
  • 11.5% to 13.5% CAGR range
  • management guidance: 15.5% to 17.5% CAGR

BTI Total Returns Since 1986

(Source: Portfolio Visualizer)

Management says it can continue to deliver historically market and aristocrat crushing returns.

Analysts expect returns of close to 13% over the coming decades, which is still exceptional for a very safe 8.5% yielding Ultra SWAN aristocrat.

BTI Investment Decision Score

Ticker BTI DK Quality Rating 13 83% Investment Grade A
Sector Consumer Staples Safety 5 82% Investment Score 97%
Industry Tobacco Dependability 5 86% 5-Year Dividend Return 49.65%
Sub-Industry Tobacco Business Model 3 Today's 5+ Year Risk-Adjusted Expected Return 16.01%
Ultra SWAN, Phoenix, Top Buy, Strong ESG
Goal Scores Scale Interpretation
Valuation 4 Ultra-Value Buy BTI's 48.86% discount to fair value earns it a 4-of-4 score for valuation timeliness
Preservation of Capital 6 Above Average BTI's credit rating of BBB+ implies a 5% chance of bankruptcy risk and earns it a 6-of-7 score for Preservation of Capital
Return of Capital 10 Exceptional BTI's 49.65% vs. the S&P's 9.21% 5-year potential for return via dividends earns it a 10-of-10 Return of Capital score
Return on Capital 10 Exceptional BTI's 16.01% vs. the S&P's 3.95% 5-year risk-adjusted expected return (RAER) earns it a 10-of-10 Return on Capital score
Total Score 30 Max score of 31 S&P's Score
Investment Score 97%

Excellent

73/100 = C(Market Average)
Investment Letter Grade A

(Source: DK Automated Investment Decision Tool)

For anyone with its risk profile, BTI is the best high-yield global aristocrat you can buy today.

Risk Profile: Why British American Isn't Right For Everyone

There are no risk-free companies and no company is right for everyone. You have to be comfortable with the fundamental risk profile.

BTI's Risk Profile Includes

  • political/regulatory risk (most notably plain packaging laws and tobacco taxes)
  • smoke-free transition risk (PM is the industry leader and BTI a distant second)
  • margin compression risk (in case of plain packaging, higher taxes on RRPs, and the potential for RRPs to prove less profitable than cigarettes) - thus far RRPs are actually more profitable due to favorable tax treatment
  • talent retention risk
  • supply chain disruption risk (such as the pandemic effects)
  • currency risk

And this is not a complete list.

(Source: BTI earnings release)

This exceptional management team and adaptable corporate culture know how to manage its risks, as its 35 years of exceptional dividend growth and market-crushing returns prove.

How We Monitor BTI's Risk Profile Over Time

  • 20 analysts
  • 3 credit rating agencies
  • 8 total risk rating agencies
  • 28 experts who collectively know this business better than anyone other than management

BTI Long-Term Risk Management Consensus

Rating Agency Industry Percentile

Rating Agency Classification

MSCI 37 Metric Model 58.0% BBB, Average
Morningstar/Sustainalytics 20 Metric Model 84.6% 26.8/100 Risk
Reuters/Refinitiv 500+ Metric Model 99.4% Excellent
S&P 1,000+ Metric Model 84.0% Excellent
Consensus 81.5% Very Good
FactSet Qualitative Assessment Average Positive Trend

(Sources: MSCI, Morningstar, Reuters, S&P, FactSet Research)

BTI's Long-Term Risk Management Is The 41st Best In The Master List (87th Percentile)

(Source: DK Master List) - 4 non-rated companies mean BTI is in 41st place

The DK 500 Master List includes the world's highest quality companies including:

  • All dividend champions

  • All dividend aristocrats

  • All dividend kings

  • All global aristocrats (such as BTI, ENB, and NVS)

  • All 13/13 Ultra Swans (as close to perfect quality as exists on Wall Street)

  • 40 of the world's best growth stocks (on its way to 50)

BTI is of higher quality than 73% of the world's best companies and its risk-management consensus is similar to that of MA, TGT, JNJ, CL, and HON.

When the facts change, I change my mind. What do you do sir?" - John Maynard Keynes

There are no sacred cows at Dividend Kings. Wherever the fundamentals lead we always follow. That's the essence of disciplined financial science, the math retiring rich and staying rich in retirement.

Bottom Line: British American Tobacco Is Set To Soar And Too Cheap To Ignore

I totally understand why many investors are skeptical of BTI during its longest bear market in 35 years.

However, the facts are clear. BTI is NOT a dying company, but a steadily growing one.

Management's plans for a smoke-free future are going better than expected and the company is also one year ahead of schedule in cost-cutting. De-leveraging could be completed this year, and in 2022 BTI could start buying back stock at up to 7% of shares each year.

The bond market, credit rating agencies, and all 20 analysts that collectively know BTI better than anyone other than management, all agree, BTI has a bright future and is a screaming bargain at 7.2x forward earnings. That's a 50% historical discount.

The last time BTI was 50% undervalued it soared 1800% over the next 15 years.

Over the next five years, if BTI grows as expected and returns to historical fair value, it could triple in value.

In a highly overvalued market, BTI represents

  • high-yield investing done right
  • dividend growth investing done right
  • dividend aristocrat investing done right
  • deep value investing done right
  • total return investing done right
  • ESG investing done right

Simply put, BTI at the best valuations in 20 years, is smart investing done right.

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This article was written by

Dividend Sensei profile picture
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Maximize your income with the world’s highest-quality dividend investments

Adam Galas is a co-founder of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 5,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.


The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha).


I'm a proud Army veteran and have seven years of experience as an analyst/investment writer for Dividend Kings, iREIT, The Intelligent Dividend Investor, The Motley Fool, Simply Safe Dividends, Seeking Alpha, and the Adam Mesh Trading Group. I'm proud to be one of the founders of The Dividend Kings, joining forces with Brad Thomas, Chuck Carnevale, and other leading income writers to offer the best premium service on Seeking Alpha's Market Place.


My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives.


With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and safe and dependable income streams in all economic and market conditions.


Disclosure: I/we have a beneficial long position in the shares of BTI either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Dividend Kings owns BTI in our portfolios.

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