Is Rio Tinto plc A Promising Capital-Growth Investment?

Rio TintoThose invested in Rio Tinto (LSE: RIO) (NYSE: RIO.US) did well on capital gains over the last 10 years. The resource firm’s shares rose about 140% over the period.

Those invested in Rio Tinto did poorly over the last six years. The shares dropped around 50%

Those invested in Rio Tinto did well over the last five-and-a-half years. The shares rose about 200%.

Those investing in Rio Tinto for the next 10 years may do spectacularly well as the shares multi-bag, or they may lose money as the shares halve.

Investing or gambling?

The firm’s inherent cyclicality leads to some particularly violent share-price fluctuations. Output commodity prices oscillate with the whims of demand, and a commodity business such as Rio Tinto has very little pricing power. The firm must sell its production into a market that dictates what it will pay.

When the market says the price will be low, Rio Tinto’s profits and cash flow go down, taking the share price with them. The outcome for investors can be catastrophic, or wonderful, depending on which side of the movement the bet is placed and at which point in the share-price cycle.

One thing seems certain, though: Rio Tinto and other big resource companies are not the best candidates for a long-term investment on the stock market. The outcome could go either way. Those making money on resource stocks are doing it by taking a short-term approach that attempts to time the cycle.

Forget buy-and-forget when it comes to Rio Tinto. It doesn’t matter how hard the firm is working right now to ramp-up production or to cut costs, or how big the dividend payment might be, the risk of share-price and dividend reversal is always present

Muted demand

Iron ore prices have been down lately thanks to muted demand from big buyers such as China. Rio Tinto gets nearly half its turnover from producing iron ore, so a price recovery could catalyze share-price uplift from today’s 3042p.

On the other hand, the iron-ore price could half. Why not? We might think we have a good idea that it won’t, but we don’t know for sure. Under such conditions, and with Rio Tinto’s share price dangling midway between its two recent extremes, the firm strikes me as a big no-no for either a long- or a short-term speculation.

With Rio Tinto, the firm adds no value to the finished product that might help it to filter out some of the wilder and more transient macro-economic fluctuations. The firm is as commoditised as it’s possible to become. Perhaps I’m better off investing in a ‘proper’ firm producing ‘proper’ goods or services, which has potential to expand if it does well. I don’t think Rio Tinto is a promising capital-growth investment, as the characteristics of the industry seem more closely aligned with gambling and guess-work than with considered and researched investing.

What now?

Rio Tinto is not for me at the moment, although I would consider a short-term punt if the inflexion point of the share price seemed more clearly defined — perhaps when profits were at a multi-year low, for example.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.