Is British American Tobacco Stock a Long-Term Buy?

Tobacco stocks aren't for everyone. The fact that they deal in vices and sell addictive products is off-putting to some, while others skip over them in favor of faster-growing businesses. British American Tobacco (NYSE: BTI) is one of the industry's most prominent players, boasting a global presence and a diverse portfolio of cigarette brands and smoke-free nicotine products.

The stock's nearly 7% dividend yield offers firm short-term returns, which investors can appreciate when market volatility rises, as it has recently.

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But can you trust British American Tobacco as a long-term holding in your portfolio? There are some risks, but the upside could surprise you.

Emerging from a tumultuous decade

It has been a particularly rough decade for British American Tobacco, also known as BAT. The stock languished for years as the company worked through two primary challenges:

1. The early stages of an industrywide shift away from cigarettes to smoke-free nicotine products.
2. The consequences of overpaying to merge with Reynolds American in 2017, including a $31.5 billion non-cash write-down on its U.S. cigarette brands in late 2023.

Now the dust is settling.

Tobacco companies are transitioning to electronic cigarettes (vapes), heated tobacco, and oral nicotine pouches, and British American Tobacco is competing. Organic, currency-neutral sales for new category products grew by 8.9% in 2024, rising to 17.5% of total revenue. British American Tobacco is trailing Philip Morris International in its smoke-free efforts, but is ahead of Altria Group, which still depends overwhelmingly on Marlboro cigarettes in the U.S.

Combustible cigarette volumes are declining, but BAT is increasing prices to offset the losses -- a classic tactic for tobacco companies.

Continued growth in new category products and stable cigarette revenues could drive modest but steady long-term growth. Management anticipates 3% to 5% annualized currency-neutral revenue growth starting in 2026. That won't light the world on fire, but it's a path forward from a brutal stretch.

Dividend reinvestment is the path to maximizing returns

The beauty of British American Tobacco is that you don't need blazing growth to produce excellent investment returns.

British American Tobacco's dividend yields 7%. If it hits its growth goals and maintains profit margins, the company could generate total annual returns of 10% to 12% over the long term, and that's without factoring in dividend reinvestment. Pump those dividends right back into the stock, and you're going to see some serious compounding over time.

Some investors question the sustainability of the dividend, but I don't see an issue.

British American Tobacco generated 7.9 billion pounds in free cash flow in 2024 and paid out 5.2 billion pounds in dividends. That's a payout ratio of 66%, leaving a substantial amount left over. Additionally, the company owns approximately a quarter of ITC, an Indian conglomerate with a market value of 5.38 trillion rupees, or roughly $63 billion. That's a valuable asset for BAT, and gives the dividend -- a top financial priority for tobacco companies to begin with -- an extra safety net.

Why the stock should perform better over the next decade

Right or wrong, share prices can influence how investors might view a stock. British American Tobacco is up 43% over the past year, but down 25% from a decade ago.

Fortunately, it appears that the stock's recent momentum is the start of a new era. British American Tobacco's price-to-earnings ratio peaked at about 24 at the end of 2017. It slowly unwound for years, a major contributor to the stock's lousy performance.

British American Tobacco hit bottom at under 8 times earnings early last year, following its massive write-off. Now, with a brighter future ahead, the market is buying. The stock's valuation has risen, but it's still under 10 times 2025 earnings estimates. Investors probably shouldn't expect shares to return to 24 times earnings anytime soon, but the current price is reasonable at the very least.

It should enable shareholders to enjoy returns in line with the company's growth and dividends moving forward. That should make long-term investors very happy.

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Justin Pope has no position in any of the stocks mentioned. The Motley Fool recommends British American Tobacco P.l.c. and Philip Morris International and recommends the following options: long January 2026 $40 calls on British American Tobacco and short January 2026 $40 puts on British American Tobacco. The Motley Fool has a disclosure policy.