In the last three months, shares in Rio Tinto (LSE: RIO) have made a major comeback. The iron ore-focused mining company has recorded a 34% gain during the period and for investors in the company, this has been a welcome event. After all, Rio Tinto’s performance in recent years has been dire and has left many of its investors in the red.
Potential to outperform
However, it could be argued that Rio Tinto’s recovery in the last quarter pales into insignificance when compared to the share price gains made by resources peer 88 Energy (LSE: 88E). Its shares have risen by a whopping 524% in the last three months due to it making a vast shale discovery in Alaska earlier this year. Since then, 88 Energy has also announced an increase in the independent resource estimate for the Icewine project in Alaska, with the probability of geologic chance of success rising to 60% from 40%.
Clearly, 88 Energy has the potential to deliver a high level of profitability in the long run and if news flow continues to be positive, its shares could continue to outperform those of Rio Tinto. However, it remains a far riskier investment than Rio Tinto, partly because it is relatively small, has no revenue and is highly dependent upon news flow to push its share price higher over the short to medium term.
Of course, Rio Tinto is not without risk. If the iron ore price falls heavily for example, its profitability would take a major hit. However, Rio Tinto has a very sound balance sheet with strong cash flow and should therefore be able to withstand a downturn in the resources industry better than the smaller and less financially secure 88 Energy. Furthermore, with Rio Tinto having one of the lowest cost bases within the iron ore mining space, it has a competitive advantage over many of its peers and this should enable it to deliver industry-leading profitability over the medium to long term.
The superior buy
On the topic of profit growth, Rio Tinto is expected to grow its bottom line by 27% in the 2017 financial year. Even though its shares have risen strongly of late, they still trade on a price to earnings (P/E) ratio of 23.8 which, when combined with its rating, equates to a price to earnings growth (PEG) ratio of just 0.9. This indicates that while Rio Tinto may not be able to match 88 Energy’s share price rise of 524% in the last three months, it does have considerable potential rewards on offer over the medium to long term.
As such, it appears as though Rio Tinto’s risk/reward ratio is more favourable than that of 88 Energy’s. While the latter could easily beat Rio Tinto in terms of capital gains in the coming months, for most investors the lower risk of the mining major combined with its still handsome potential rewards make it the superior buy right now.
