Few stocks have delivered a more reliable combination of income and capital growth over the last decade than FTSE 100 giants Imperial Tobacco Group (LSE: IMT) (NASDAQOTH: ITYBY.US) and British American Tobacco (LSE: BATS) (NYSEMKT: BTI.US).
BAT has delivered an average annual total return (share price gains plus dividends) of almost 17% over the last ten years, while Imperial has managed 12% per year.
The FTSE 100 has managed just 6.9%.
The perfect stock?
Warren Buffett once said that he liked tobacco stocks because:
“It costs a penny to make. Sell it for a dollar. It’s addictive. And there’s fantastic brand loyalty.”
This description of Big Tobacco remains true today — and it pretty much describes the ideal investment, ethical considerations aside.
Here in the UK, there are only really two choices — Imperial or British American — so I’ve taken a look to see which looks most attractive in today’s market.
Back to basics
Let’s start with some simple fundamentals: which stock looks cheaper, based on forecast earnings and yield?
| Ratio | British American | Imperial |
|---|---|---|
| 2015 forecast P/E | 16.8 | 14.6 |
| 2015 prospective yield | 4.2% | 4.6% |
Both companies have forecast P/E ratios slightly ahead of the FTSE 100 average, but both also offer significantly higher yields than the FTSE.
What’s more, both companies boast incredible earnings and dividend growth records:
|  | British American | Imperial |
|---|---|---|
| 10 yr. average earnings per share growth | 10.9% | 6.1% |
| 10 yr. average dividend growth | 13% | 8.6% |
Based on these numbers, British American Tobacco looks a more attractive buy — both earnings per share and the dividend have grown faster than at Imperial.
The price of growth
However, BAT’s extra growth comes at a price. We’ve already seen that the firm’s shares trade on a higher forecast P/E than those of Imperial.
As it turns out, BAT shares trade at a much higher value relative to average historical earnings, too:
| Company | Price/10-year average earnings (PE10) |
|---|---|
| British American | 25.2 |
| Imperial | 18.8 |
To be fair, one reason BAT’s PE10 is so much higher is because its earnings have grown so relentlessly, rising every year for at least a decade.
At Imperial, earnings haven’t grown quite so consistently, and nor has the share price.
Which stock would I buy?
Imperial updated the market with a solid trading statement this week, and I think it’s fair to say that the firm has started to address its underperformance relative to British American over the last couple of years.
Although BAT has outperformed its smaller peer in the past, in today’s market I’d be tempted to choose Imperial’s higher yield, lower valuation and stronger earnings growth prospects.
The best income choice
Before you hit the buy button on either stock, however, I would urge you to take a closer look at each firm’s dividend, to ensure there are no hidden warning flags.