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Imperial Tobacco Group PLC vs British American Tobacco plc: Which Stock Is The Better Buy?

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.

A fast, easy way to test the safety of a firm's dividend is to use the five golden dividend rules that are explained in "How To Create Dividends For Life", an exclusive new report from the Motley Fool's income experts.

This report is free and without obligation and could save you from a very costly mistake.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.