Where does the Rio Tinto share price go from here?

Here’s why I’m strongly considering Rio Tinto (LSE:RIO) shares for my portfolio in the current environment.

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As far as top FTSE 100 players are concerned, Rio Tinto (LSE:RIO) shares are among the most highly sought-after in the commodities space. The rapid increase we’ve seen in commodity prices this year has certainly benefited miners with broad operations. Given Rio Tinto’s expansive portfolio of minerals mined – everything from base metals to precious metals, uranium, and salt – a rising tide in the commodities space has certainly lifted this boat.

However, given the recent ‘coming to earth’ commodity prices have seen, questions remain about where Rio Tinto shares could be headed next. Given this is a stock I’m considering for my portfolio, I’ve been taking a hard look at this miner.

Just look at that dividend…

Among a list of the top FTSE 100 stocks, Rio Tinto shares take third place in terms of current dividend yield. The company’s 9.2% dividend yield is staggering. Indeed, surging iron ore and copper prices have produced incredible profits for this mining juggernaut. Accordingly, Rio Tinto’s management team hasn’t been shy about dishing out these profits to shareholders in the form of dividends.

Now, it’s worth nothing that a significant chunk of Rio Tinto’s dividend yield is a result of a special dividend. The company’s special half-year dividend will cost Rio Tinto around US$3bn. These special dividends are sure nice for investors. However, many investors (myself included) subtract these special dividends from their calculations. This is because such dividends are paid out sporadically, based on performance. Accordingly, there is significant risk in assuming Rio Tinto shares will pay out a 9.2% dividend yield over the long term.

Booming earnings lift Rio Tinto shares 

The key driver of Rio Tinto’s recent massive dividend payouts is the company’s stellar earnings. Over the past two quarters, the company grew its net earnings by more than 270%. As an investor looking for some mining exposure, these kind of explosive earnings are appealing to me.

Rio Tinto’s diversified business model is something I like. When looking across the mining sector, it’s difficult to find a comparable to Rio Tinto. Indeed, as far as size and quality go, Rio Tinto shares are among the best I can find in this sector.

That said, should commodity prices continue leveling out, I remain cautious with respect to future earnings growth from here. Thus, in my financial model, I’m assuming as a base case that things will continue as they are. 

The bottom line

Rio Tinto shares are currently valued at around 6.4 times trailing 12 month earnings. For a fundamental investor such as myself, that’s intriguing. Accordingly, this is as stock that tops my watch list right now in the commodity sector.

However, I’m also a realist. The rising commodity prices we’ve seen during the first half of this year are likely unsustainable. Rising coronavirus cases resulting from the delta variant pose a real threat to commodity price strength. Accordingly, I’m factoring in a significant buffer with this stock.

That said, I view Rio Tinto shares as a solid hedge against inflationary pressures (in a bullish economic environment). Should the economy slow, I think Rio Tinto’s diversified business model provides a significant margin of safety. Accordingly, this is a stock I’m considering for my portfolio right now.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Chris MacDonald has no position in any shares mentioned in this article. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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