Rio Tinto (LSE: RIO), the world’s largest iron ore miner, posted respectable results and a massive dividend last month. With my discretionary income anticipated to decline in the present high-inflation climate, I’ll go through why I’m thinking of adding Rio Tinto shares to my portfolio as a way to earn passive income.
A dividend yield that beats inflation
As energy and food costs continue to surge, inflation is likely to rise further in April. Rio Tinto declared an astronomical 8.8% dividend yield ($10.40 per share) during its results call, while the Bank of England expects inflation to peak at 7.25%. Dividend yields decrease as the stock price rises, but if I were to acquire the stock at its current price, this would outperform the predicted inflation rate. As a result, I think the commodity giant would be a good addition to my portfolio.
Growth potential
Even though many experts expect Rio Tinto’s growth to slow in the short-to-medium term, I remain optimistic about the company’s potential to at least continue its present trajectory. The majority of its revenue comes from China, the world’s greatest producer of iron ore (57.2%).
Rio Tinto hopes to profit from the robust economic resurgence following Covid since China is a rising market with space to grow in the manufacturing sector. Following a recession, many countries tend to invest extensively in manufacturing, and China will be no exception. Positive official manufacturing production data, which have increased every month since April 2020, have further encouraged this mood.
Furthermore, if the price of iron ore continues to crawl back up around $150 per Dry Metric Ton, a bullish commodity market will aid profit margins for the foreseeable future. It’s also worth mentioning that Rio’s stock is now selling at a discount to its all-time high of 13%. With a price-to-earnings (P/E) ratio of 6.63, the stock has the potential to rise in the months running up to its ex-dividend date in April.
Downside risks
Despite all of the advantages of purchasing Rio Tinto, there are a few risks linked to the company’s stock. For one thing, many analysts believe the dividend could decline over the next three years as a result of weaker economic growth and higher processing costs. This could wipe out any special dividend and force Rio Tinto to revert to its ordinary dividend yield of around 5%. Increasing energy and labour expenses have already put a ceiling on the company’s earnings potential in 2021, according to the company’s results report.
Furthermore, Rio Tinto’s profit margins will be influenced by the price of iron ore, which might fall as low as it did in late 2021.
Nonetheless, I’m contemplating adding Rio to my portfolio while keeping an eye on the macroeconomic situation leading up to the ex-dividend date.
James Reynolds has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.
