I used to own shares of both halves of the Philip Morris tobacco empire -- Altria (NYSE:MO), which is based in the U.S., and its overseas counterpart, Philip Morris International (NYSE:PM). But in 2014, I sold my shares of PMI and doubled up on Altria, since it was shielded from overseas economic problems and currency fluctuations. But earlier this year, I sold my shares of Altria and invested in PMI again, for three main reasons.

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Altria and PMI's flagship Marlboro brand. Source: Pixabay.

1. The dividend
Altria's stock has risen 64% over the past 24 months and easily outperformed PMI's 12% gain. However, that steep climb has also reduced Altria's yield to just 3.6% -- its lowest point in recent history. PMI now pays a higher yield of 4.5%.

Over the past 12 months, Altria paid out 75% of its free cash flow as dividends, while PMI paid out 98%. On an EPS basis, Altria paid out 80% of its earnings, while PMI paid out 86%. PMI's higher payout ratios indicate that it's willing to spend more heavily on dividends than Altria, but it also means that Altria has more room to raise its dividend in the future. Yet during Altria's past five annual dividend increases, it raised its dividend by an average of just 8.1%, compared with PMI's average of 9.9%.

As an investor who mainly buys income-generating stocks, I find that PMI's higher yield, payout ratio, and record of bigger dividend increases make it more attractive than Altria.

2. The valuation
Altria had a great run over the past five years, but its valuations are getting ahead of the stock. Altria has a P/E ratio of 22, while PMI and the rest of the tobacco industry trade at 19 times earnings. Altria's forward P/E of 18 looks better, but it still looks pricey compared with its projected earnings growth rate of 9.5% for fiscal 2016.

Altria's valuation makes it an easy target for sellers as interest rates rise, since some income investors are expected to dump dividend stocks with higher valuations and retreat to bonds instead. PMI's forward P/E of 20 doesn't look great compared with its projected earnings growth rate of 2.3% for 2016, but we should remember that the company's real earnings growth potential is chained down by foreign exchange rates.

3. The dollar
Altria is a great stock to own as long as the dollar remains strong and low gas prices boost discretionary spending. But once those trends reverse, Altria will probably underperform PMI, which has access to much higher growth markets.

During the fourth quarter, Altria's revenue rose only 2.6% annually to $4.73 billion and missed estimates by $10 million. PMI's revenue fell 11.8% annually last quarter to $6.93 billion, beating estimates by $170 million. But excluding a $1.4 billion currency impact, PMI's total revenues actually rose 5.9%. A geographic breakdown of PMI's revenue reveals how much a strong dollar has throttled its growth.

Region

Annual Revenue Growth

Excluding Currency Impacts

% of Total Revenues

European Union

(13.4%)

4.5%

29.5%

EEMA*

(13.8%)

9%

30.3%

Asia

(11.1%)

0.9%

28.6%

Latin America/Canada

(3.5%)

13.9%

11.6%

Source: PMI Q3 report. *East Europe, Middle East, Africa.

These headwinds will probably weigh down PMI's fourth-quarter and full-year earnings, which it will report on Feb. 4. But if Federal Reserve rate increases weaken the dollar (which has historically occurred over the long term), PMI's forex headwinds could gradually dissipate. If that happens, it could be PMI's turn to finally outperform Altria.

Will this tobacco trade pay off?
I'm not certain that PMI will outperform Altria this year. The dollar might remain strong and the Fed could delay rate increases, which could encourage investors to overlook Altria's higher valuation and lower dividend. But for investors looking for a tobacco play with a lower valuation and a higher dividend, Philip Morris International might be a better long-term bet.

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Leo Sun owns shares of Philip Morris International. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.