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Is Rio Tinto plc A Better Income Stock Than British American Tobacco plc?

With the mining sector having endured a challenging period of late, shares such as Rio Tinto (LSE: RIO) (NYSE: RIO.US) are now offering great value and an even better yield. In fact, Rio Tinto now yields an incredible 4.8%, which is clearly considerably higher than the FTSE 100‘s yield of around 3.3% and is, therefore, very appealing to income-seeking investors. It is also much higher than the 4.2% on offer at British American Tobacco (LSE: BATS) (NYSE: BTI.US), which has traditionally been a stalwart of income portfolios.

Does this mean that Rio Tinto is now a more appealing income stock than British American Tobacco? Or, should you stick with the latter for a great long-term income?

Volatility Vs Stability

As mentioned, the mining sector is in a state of flux and profitability for miners such as Rio Tinto has bombed. Certainly, it is doing all of the right things to maximise its profitability, such as reducing capital expenditure, cutting costs and mothballing ambitious projects, but the fact remains that its yield is so high due to the challenges it faces and this makes it a relatively risky income play.

On the other hand, British American Tobacco offers a lower yield, but much greater stability. That’s because demand for tobacco is very consistent whatever the performance of the wider economy and this has enabled British American Tobacco to increase its bottom line in each of the last four years. This stability equates to a greater chance that dividends will be paid in full in each year, while for Rio Tinto a further fall in the iron ore price (which is a very real threat) could cause it to cut dividends in order to improve its cash flow.

Headroom

Despite this greater volatility, Rio Tinto has more headroom than British American Tobacco when making dividend payments. For example, it has a dividend payout ratio of 62%, which is lower than British American Tobacco’s 70%. Certainly, both companies do not appear to be sacrificing reinvestment for the sake of a generous shareholder payout, but Rio Tinto appears to have more scope to increase dividends in the short term than British American Tobacco does, simply because it pays a lower proportion of profit as a dividend at the present time.

Looking Ahead

Both companies are forecast to increase dividends at a rapid rate, with Rio Tinto’s dividends set to rise by 7.1% and British American Tobacco’s by 6.9% next year. Both of these growth rates are hugely appealing and way in excess of current levels of inflation, thereby providing a substantial real terms increase in income for their investors.

Furthermore, the outlook for both companies appears to be relatively bright. In British American Tobacco’s case, e-cigarettes are providing a new and highly lucrative growth space, while for Rio Tinto the potential for a Chinese stimulus programme could push its share price higher over the medium term.

The Better Income Stock

However, when it comes to which is the better income play, British American Tobacco still beats Rio Tinto. Certainly, it has a lower yield, lower dividend growth rate and a worse payout ratio, but the added stability and consistency that it offers over Rio Tinto make its dividends much more certain. So, while Rio Tinto is a great company and a very viable income stock, it still is not on a par with British American Tobacco, which is one of the most appealing income plays around.

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Peter Stephens owns shares in Rio Tinto and British American Tobacco. 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.