Investor Essentials Daily

It is hard to quit smoking

British American Tobacco (BTI)
May 7, 2024

During economic downturns, investors often shift their capital to more stable assets like cash, gold, and safer parts of the stock market.

Companies like British American Tobacco (BTI), which sells addictive products such as tobacco, benefit from consistent customer demand even when disposable incomes are tight.

Despite challenges from regulatory pressures aimed at reducing smoking, British American Tobacco continues to provide stable earnings and an attractive dividend yield of 9.8%.

Additionally, a recent decision by the U.S. government to not ban menthol cigarettes has temporarily alleviated some pressure on the tobacco industry, allowing British American Tobacco more time to adapt to market changes while maintaining profitability in their traditional tobacco businesses.

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Yesterday we discussed how in times of economic uncertainty, investors seek to move their capital into safer asset classes that provide stability and downside protection.

This includes moving into safe havens like cash, gold, treasury bills, and the safer parts of the stock market.

A major component of the safer stock market includes companies that provide addictive products and services, which allows them to maintain relatively stable revenues and cash flows even during economic downturns.

Their customers tend to be “sticky” in that they continue purchasing the products even when disposable incomes are constrained. Alcohol and tobacco firms are prime examples of such businesses.

British American Tobacco (BTI), a top tobacco player, is among one of these names.

Despite the ongoing economic volatility and uncertainty, British American Tobacco has continued delivering stable earnings year-over-year.

This earnings resilience can be attributed to the non-discretionary nature of cigarette consumption and the company’s global scale.

In addition to stable cash flows, British American Tobacco also offers an attractive dividend yield of around 9.8% currently, far higher than most other large-cap stocks and fixed-income instruments.

This makes the stock compelling from a total return perspective for investors seeking income during turbulent markets.

However, tobacco stocks do face significant long-term headwinds from ongoing regulatory and legal challenges aimed at reducing smoking rates globally.

Governments and public health organizations continue to impose various restrictions on tobacco product marketing, advertising, and sales. Rising health awareness and anti-smoking campaigns have also taken a toll on cigarette consumption over time.

A recent development has provided some temporary relief on this front.

The U.S. government reversed its plan to implement a nationwide ban on menthol cigarettes starting next year.

As the second largest cigarette market globally, a menthol ban in the U.S. would have dealt a major blow to British American Tobacco and its peers. Menthol cigarettes currently account for over 40% of total U.S. cigarette volume.

This policy change indicates the timeline for transitioning to a “smokeless future” may be more extended than anticipated based on recent regulatory actions.

It buys the tobacco companies some additional time to further diversify away from combustible products. In the meantime, British American Tobacco is poised to keep generating profits from its conventional tobacco business.

British American Tobacco offers a compelling low-risk return profile for more conservative allocation within the stock market.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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