British American Tobacco (LON:BATS) Will Pay A Larger Dividend Than Last Year At UK£0.54

British American Tobacco p.l.c. (LON:BATS) has announced that it will be increasing its dividend on the 17th of August to UK£0.54. This takes the annual payment to 6.1% of the current stock price, which is about average for the industry.

View our latest analysis for British American Tobacco

British American Tobacco's Dividend Is Well Covered By Earnings

We aren't too impressed by dividend yields unless they can be sustained over time. Prior to this announcement, British American Tobacco's dividend made up quite a large proportion of earnings but only 55% of free cash flows. Since the dividend is just paying out cash to shareholders, we care more about the cash payout ratio from which we can see plenty is being left over for reinvestment in the business.

Over the next year, EPS is forecast to expand by 9.4%. Assuming the dividend continues along recent trends, we think the payout ratio could be 70% by next year, which is in a pretty sustainable range.

Dividend Volatility

The company has a long dividend track record, but it doesn't look great with cuts in the past. Since 2012, the first annual payment was UK£1.27, compared to the most recent full-year payment of UK£2.18. This means that it has been growing its distributions at 5.6% per annum over that time. It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. British American Tobacco might have put its house in order since then, but we remain cautious.

Dividend Growth May Be Hard To Achieve

With a relatively unstable dividend, it's even more important to see if earnings per share is growing. Earnings per share has been crawling upwards at 3.7% per year. Earnings are not growing quickly at all, and the company is paying out most of its profit as dividends. When a company prefers to pay out cash to its shareholders instead of reinvesting it, this can often say a lot about that company's dividend prospects.

In Summary

Overall, it's great to see the dividend being raised and that it is still in a sustainable range. The dividend has been at reasonable levels historically, but that hasn't translated into a consistent payment. Taking all of this into consideration, the dividend looks viable moving forward, but investors should be mindful that the company has pushed the boundaries of sustainability in the past and may do so again.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. Taking the debate a bit further, we've identified 2 warning signs for British American Tobacco that investors need to be conscious of moving forward. Is British American Tobacco not quite the opportunity you were looking for? Why not check out our selection of top dividend stocks.

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