Tobacco giant Altria (NYSE:MO), formerly known as Philip Morris USA, is one of my favorite dividend stocks. But unlike other "low growth" income stocks, Altria rallied nearly 29% in 2014, easily outperforming the S&P 500's 10% gain.

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Source: Flickr.

Let's take a look at four reasons Altria is a top stock for income investors, and how it measures up to domestic rival Reynolds American (NYSE:RAI) and its international counterpart, Philip Morris International (NYSE:PM).

A high yield and payout ratio
Altria's forward annual dividend yield of 4.6% is higher than Reynolds American's 4.2%, which are both significantly higher than the S&P 500's average dividend yield of 1.9%.

Tobacco stocks also usually offer a high payout ratio (the percentage of earnings paid out as dividends). Over the past twelve months, Altria's average payout ratio of 88.5% was slightly higher than Reynolds American's 86.5%.

Both companies have a long history of raising their dividends annually, but Altria's dividend increases have consistently topped Reynolds on a percentage-wise basis. Altria respectively raised its quarterly dividend by 7.3%, 9.1%, and 8.3% in 2012, 2013, and 2014. Over those three years, Reynolds raised its quarterly dividend 5.4%, 6.8%, and 6.3%.

Altria also tops Philip Morris International in all three categories. PMI pays a forward annual dividend of 4.5%, has an average payout ratio of 73%, and only raised its dividend 6.4% this year.

Robust return on equity
But annual yields and payout ratios only tell half the story. To dig deeper, we should check Altria's return on equity (ROE).

A high ROE indicates that a company is efficient at turning shareholder money into profits. Whereas rapidly growing companies with high ROEs might reinvest their income on expanding, the tobacco market is shrinking in most developed markets. That's why tobacco companies usually spend their leftover cash, or FCF, to pay dividends and buy back stock.

Altria's ROE over the past 12 months comes in at 103.4%. Reynolds and PMI respectively have much lower ROEs of 32.1% and -91%. PMI's negative ROE, although alarming, was caused by the company taking on debt to fund more buybacks than Altria or Reynolds -- meaning that its ROE will bounce back as it repays its debt.

Healthy free cash flow
The percentage of FCF a company spends on dividends, or the FCF payout ratio, also reveals how much it values shareholders.

 

FCF (ttm)

Dividends paid (ttm)

FCF payout ratio

Altria

$4.42 billion

$3.82 billion

86%

Reynolds American

$1.53 billion

$1.40 billion

92%

Philip Morris International

$7.87 billion

$5.22 billion

66%

Source: Ycharts.

By this measure, Reynolds looks like the more generous company. However, Altria still has better long-term FCF growth. Over the past five years, Altria's annual FCF has climbed 34%, compared to a 12% decline for Reynolds and 25% growth for PMI. Since FCF fuels dividend payments, Altria is a more stable long-term choice.

Protecting the bottom line
Altria, Reynolds American, and Lorillard (NYSE:LO) control roughly 84% of the U.S. cigarette market. Yet the number of U.S. smokers has declined from 42% in 1965 to 18% in 2012, according to the Surgeon General's Report on Smoking and Health.

That's why Altria and Philip Morris International parted ways in 2008 -- the former slimmed down for the domestic market, while the latter expanded into higher growth markets overseas. This resulted in single digit revenue growth for Altria, as PMI enjoyed double digit growth overseas.

PM Revenue (Annual) Chart

Source: Ycharts.

However, Altria and Reynolds aggressively protected their bottom lines by cutting jobs and raising cigarette prices to offset volume declines. In July, Reynolds announced a $27.4 billion merger with Lorillard to stabilize cigarette growth and cut costs.

To diversify their products beyond cigarettes, both companies started selling snuff and e-cigarettes. Altria also invested in cigars and wine, while Reynolds started selling nicotine gum. Meanwhile, PMI's bottom line was weighed down by a strong dollar, which adversely affected its overseas profits.

PM Net Income (Annual) Chart

Source: Ycharts.

Reynolds and Altria's ability to grow net income by double digits as revenue only moved by single digits was impressive. Therefore, investors should be confident that Altria and Reynolds American will do all that they can to shield their profits and dividends from top line declines.

 

Leo Sun owns shares of Altria Group. 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.