Does Rio Tinto plc Pass My Triple-Yield Test?

Like most private investors, I drip-feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.

However, the FTSE’s gains mean that the wider market is no longer cheap, and it’s getting harder to find shares that meet my criteria for affordability.

In this article, I’m going to run my investing eye over Rio Tinto (LSE: RIO) (NYSE: RIO.US).

The triple yield test

Today’s low cash saving and government bond rates mean that shares have become some of the most attractive income-bearing investments available.

To gauge the affordability of a share for my income portfolio, I like to look at three key trailing yield figures –the dividend, earnings and free cash flow yields. I call this my triple yield test:

Rio Tinto Value
Current share price 3,220p
Dividend yield 3.6%
Earnings yield 8.6%
Free cash flow yield -7.0%
FTSE 100 average dividend yield 3.0%
FTSE 100 earnings yield 6.0%
Instant access cash savings rate 1.5%
UK 10yr govt bond yield 2.8%

A share’s earnings yield is simply the inverse of its P/E ratio, and makes it easier to compare a company’s earnings with its dividend yield.  Rio’s 8.6% earnings yield highlights its modest valuation and looks attractive to me, especially as analysts’ expect Rio to deliver earnings per share growth of around 13% in 2014, providing good upside potential.

Cast-iron income?

Rio also has solid credentials as an income stock, and the firm’s 3.6% dividend yield is 20% higher than the FTSE 100 average of 3%, making it an appealing choice for a diversified income portfolio, in my opinion.

Although Rio’s free cash flow has been negative for the last two years, thanks to a combination of lower earnings and a large hangover of capital expenditure commitments, I expect this to change in 2014, as lower capital expenditure and the firm’s $1.5bn cost cutting drive start to deliver benefits.

Is Rio a buy?

Rio’s iron ore mines boast a net profit margin of around 36%, and the firm recently reported a 5% increase in iron ore shipments for 2013, alongside increased production of all of its other main commodities.

Rio’s weakness is its dependency on iron ore, which accounted for nearly half of sales and 88% of net earnings during the first half of last year. However, Rio’s copper production is set to rise sharply this year, as its Oyu Tolgoi mine in Mongolia ramps up production.

I believe Rio looks very good value at current prices, and rate the miner as a strong buy for 2014.

If, like me, you've already loaded up your portfolio with Rio stock, and are looking for new investment ideas, then I'd recommend you take a look at the five companies profiled in a special Motley Fool report, "Five Shares To Retire On".

These five firms currently offer an average prospective yield of 4.3%, and all five are genuine blue chips names, with a strong record of dividend growth.

To find out more, click here to download your FREE copy of this valuable report, while it's still available.

> Roland owns shares in Rio Tinto.