When it comes to capital gains in 2014, neither Rio Tinto Limited (ASX: RIO) nor BHP Billiton Limited (ASX: BHP) have compared favourably to the ASX. That's because, while the index is up 4% since the turn of the year, shares in Rio Tinto have fallen by 9% and BHP Billiton has seen its share price decline by 6%. Looking ahead, though, which one could prove to be the better investment?
Tough Conditions
Clearly, 2014 has been a tough year for both companies. Indeed, Rio Tinto has been hit by a falling iron ore price and, since it accounts for the overwhelming majority of its profit, the company's bottom line has come under pressure. Likewise, BHP Billiton's reliance on iron ore has meant that it is feeling the heat. Of course, due to its better diversification, BHP Billiton seems better able to cope than Rio Tinto, although the former still relies heavily on iron ore as its biggest money-making commodity.
Looking Ahead
The future is expected to be much brighter for BHP Billiton. For example, it is forecast to overcome a challenging current year (where EPS is due to fall by 6.1%) by posting much better bottom line numbers next year. Indeed, EPS is expected to rise by 21.5% in FY 2016, which would be a great result for shareholders.
However, the future looks a little less rosy for Rio Tinto. That's because its earnings are due to fall by 26.8% in the current year before increasing by a lowly 3% in FY 2016. Although it's encouraging to see a bounce back in FY 2016 is being pencilled in for Rio Tinto, it's still someway off the performance that is expected to be delivered by BHP Billiton during the same time period.
Valuations
While Rio Tinto's prospects are less upbeat than its sector peer, it trades on a much lower P/E ratio than its rival. Rio Tinto's P/E ratio is currently just 9.9, which shows that there is considerable scope for an upward revision to its rating – especially when the ASX has a P/E ratio of 15.8.
There's also potential for an upward rating revision for BHP Billiton. It has a P/E ratio of 13.4 which, although higher than that of Rio Tinto, is still 15.2% lower than that of the ASX. Furthermore, when BHP Billiton's P/E ratio is compared to its earnings growth prospects, it equates to a price to earnings growth (PEG) ratio of 1.98, which is far more appealing than the PEG ratio on offer at Rio Tinto.
So, while both stocks are highly dependent upon the price of iron ore, BHP Billiton's diversity seems to edge it ahead of its rival. Although both stocks continue to offer appeal in the long run, BHP Billiton could prove to be the better investment as a result of its superior earnings growth potential.
