FTSE big-hitter Rio Tinto (LSE: RIO) has had a rough time of it recently, along with other commodities firms.
The key reason has been the uneven economic recovery of China from its Covid years. From the mid-1990s to that point it had been the world’s biggest commodities buyer. Commodities powered its stellar economic growth.
However, signs of a more sustained recovery are emerging. Last year it recorded growth of 5.2% — against an official target of “around 5%”. The same target remains in place for this year.
To that effect, 24 September saw the biggest stimulus measures announced since the end of the pandemic. These include interest rate cuts and reductions in bank reserve requirements – both aimed at increasing money flowing in the economy.
They also featured direct support for the ailing property sector, which alone accounts for around 30% of China’s economy.
Passive income potential
In 2023, Rio Tinto paid a total dividend of $4.35, fixed at a sterling equivalent of £3.4144. On the current share price of £52.96, this gives a yield of 6.4%.
By comparison, the present average FTSE 100 yield is 3.5% and for the FTSE 250 it is 3.3%.
£9,000 – the same amount I started investing with 30 years ago – would buy 170 shares in the firm.
Over a year, these would generate £576 in passive income (money made from minimal effort, most notably in my view from investing in shares that pay dividends).
Over 10 years on the same 6.4% yield, this would rise to £5,760, and over 30 years to £17,280.
The power of dividend compounding
That said, if the dividends were used to buy more Rio Tinto shares, the returns could be much higher. This is ‘dividend compounding’ in financial lingo.
Doing this on the same 6.4% average yield would give total dividend payouts after 10 years of £8,039, not £5,760. And over 30 years on the same basis, these would be £52,076 rather than £17,280!
By that time, the total Rio Tinto investment would generate £3,909 a year in passive income, or £326 each month.
My investment view
I bought the stock recently for three key reasons.
First, it has a high yield, which is increasingly important to me as I am now over 50. Such dividend payments should enable me to reduce my working commitments without my lifestyle being unduly affected.
Second, the relative undervaluation of the shares is important. This reduces the chances of these dividend gains being wiped out by share price losses, in my experience.
On the key price-to-earnings ratio (P/E) measure of stock valuation, Rio Tinto currently trades at just 10.7. This is very cheap compared to the average 28.1 P/E of its competitor group.
And third, China’s much improved economic growth prospects are a factor. A failure to realise these remains the chief risk for Rio Tinto shares, I think.
However, even if China partly undershoots its expansion target, the absolute gain in monetary trading terms could still be huge.
Specifically, even if China manages ‘just’ 4.5% annual growth, it would be equivalent to adding an economy the size of India’s to its own every four years.
