Despite its size, mining giant Rio Tinto (LSE: RIO) (NYSE: RIO.US) tends to deliver a volatile ride for investors — for example, after peaking at 3,680p in February, Rio’s share price dropped 15% to 3,140p, in just three weeks.
Although volatility like this can be offputting for investors, I don’t think it needs to be: Rio is large, profitable and pays a reliable dividend. Short-term share price movements aren’t important, unless you want to buy or sell.
Rio’s share price is now 8% higher than one year ago, but 3% lower than at the start of 2014. Is now a good time to buy?
Valuation
Let’s start with the basics: how is Rio valued against its past performance, and the market’s expectations of future performance?
| P/E ratio | Current value |
| P/E using 5-year average adjusted earnings per share | 9.4 |
| 2-year average forecast P/E | 10.4 |
Source: Company reports, consensus forecasts
Analysts’ earnings forecasts for the next couple of years are broadly in-line with Rio’s five-year average earnings, leaving Rio looking cheap.
Although earnings are expected to remain in-line with Rio’s five-year average earnings, the dividend is expected to rise: Rio currently offers a prospective yield of 3.8%, and consensus forecasts suggest that the dividend will rise by 8% this year, and in 2015.
Based on these figures, Rio remains on my buy list.
What about the fundamentals?
In the long term, a company’s market value is linked to its sales and profit growth. For miners such as Rio, these figures can be quite volatile from year-to-year, as sales and profits are linked directly to commodity prices.
However, using a five-year timeframe helps smooth these variations out — how strong is Rio’s growth record?
| 5-year compound average growth rate | Rio Tinto |
| Sales | 4.9% |
| Adjusted earnings per share | 9.1% |
| Dividend (2010 – 2013) | 12.2% |
Source: Company reports
Rio cancelled part of its dividend in 2009, so I’ve calculated dividend growth since 2010, to give a more balanced view of growth. Despite this, Rio’s four-year average dividend growth rate of 12.2% is impressive, as is the 9.1% annual growth in adjusted earnings per share.
Sales growth of 4.9% per year is respectable, given the firm’s size, and overall, Rio’s growth record looks acceptable to me, given the firm’s valuation. I’m particularly encouraged by the miner’s above-inflation dividend growth, which makes it attractive for income investors.
A long-term recipe for success?
I think Rio looks good value at its current price, and rate it as a strong buy for income.
The company’s giant low-cost ore mines mean that if the price of iron ore falls, higher-cost competitors will be squeezed out of the market, which should help to support Rio’s profits.