Should I Buy British American Tobacco or Imperial Tobacco Group?

LONDON -- Tobacco giants British American Tobacco  (LSE: BATS  ) (NYSEMKT: BTI  ) and Imperial Tobacco Group  (LSE: IMT  ) (NASDAQOTH: ITYBY  ) sell more than 1 trillion cigarettes every year.

Both companies own portfolios of leading cigarette brands, and have consolidated and optimized their large operations so that they are extremely profitable and cash generative -- making them top favorites with income investors.

Despite this, there are some big differences between the two firms. So which would I buy to add to my portfolio?

British American Tobacco vs. Imperial Tobacco
I'm going to start with a look at a few key statistics that can be used to provide a quick comparison of these two companies:

Metric 

British American
Tobacco

Imperial Tobacco

Trailing dividend yield

3.7%

4.7%

5-year average dividend yield

4.5%

4.2%

5-year dividend growth rate

15.3%

11.9%

5-year share price return

79%

(5.5%)

I've selected the figures above because they tell two different stories. BAT has a stronger presence in emerging markets than Imperial, and these markets have delivered superior growth in recent years when compared to the relatively mature markets of Europe, where Imperial's business is focused.

In the wake of the financial crisis, investors bought into BAT's high yield and growth potential. The firm's share price has risen by 79% over the last five years, driving down its yield to a more modest 3.7% -- well below its five-year average of 4.5%, and below the 4.7% offered by Imperial.

Imperial's share price has edged lower this year, and in its first-half results last week, the firm reported a 5.9% drop in cigarette volumes, a 9.7% fall in operating profit, and a 22.7% fall in reported earnings per share. However, some of this was due to one-off factors, and the firm expects to deliver modest earnings-per-share growth over the full year.

What's next?
So far this year, BAT's shares have risen by 15%, while Imperial's have dropped 2%. Can BAT continue to outperform its smaller rival, or is now the time for new investors to look again at Imperial?

Analysts' forecasts are notoriously unreliable, but FTSE 100 companies generally get the benefit of the most comprehensive analysis and tend to deliver fewer surprises than smaller companies.

With that in mind, let's take a look at some forward-looking numbers for BAT and Imperial. These apply to the companies' current financial years:

 Metric

British American
Tobacco

Imperial Tobacco

Forecast P/E ratio

15.7

11.0

Forecast dividend yield

4.2%

5%

Forecast dividend growth

11%

10%

Forecast earnings growth

12%

9%

Both companies are expected to deliver similar earnings and dividend growth this year, but British American Tobacco's premium is the price you have to pay for access to its higher-growth markets.

Imperial Tobacco, on the other hand, offers a higher yield at a lower earnings multiple, but comes with the risk that there may be a long-term decline in sales in some of its more mature western European markets.

Which share should I buy?
Imperial's greater exposure to developed markets, where smoking is in decline and the tax and regulatory regime is more hostile, looks like a growing risk to me.

I think that investors seeking a long-term, inflation-beating income are likely to be better served by investing in British American Tobacco. This firm's dividend yield remains above the market average, and further growth looks very likely.

The best FTSE 100 dividends?
British American Tobacco and Imperial Tobacco are both tempting income buys, but there are a number of other attractive, high-yielding alternatives elsewhere in the FTSE 100 you may also want to consider.

Indeed, I can tell you that the tobacco sector wasn't chosen by The Motley Fool's team of analysts for their latest special report, "5 Shares to Retire On." If you would like to know the identity of these five top-rated dividend investments, click here now to download your copy of this report -- it's free, but availability is strictly limited, so don't delay.

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