Can I trust Rio Tinto’s 10.3% dividend yield?

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Rio Tinto’s (LSE: RIO) dividend yield has rocketed in 2022 as the miner’s share price has sunk. This has led plenty of income investors to buy the FTSE 100 stock, myself included. That’s despite the growing threat to its profits as the global economy cools.

At the moment, Rio Tinto’s dividend yield for 2022 sits at a mighty 10.3%. This is well above the Footsie index average of 3.7%. It falls next year, but will still sit at a market-beating 8.8%.

But — can I believe these forecasts, given the uncertain outlook for commodities prices?

Drilling down

First off, let’s see how these predicted dividends at Rio Tinto are covered by anticipated earnings.

The miner is tipped to dish out a total ordinary dividend of 624 US cents per share in 2022. This is expected to drop to 534.4 cents next year.

These expected payments are both down from the ordinary dividend of 793 cents Rio Tinto paid in 2021. And they reflect that brokers expect earnings to steadily fall over the next couple of years. Bottom-line declines of 25% and 20% are forecast for 2022 and 2023 respectively.

This means that Rio Tinto’s estimated dividends are covered between 1.5 times and 1.6 times by expected earnings. This is below the widely accepted safety territory limit of 2 times and above.

However, it’s also important to consider a company’s balance sheet when discussing potential dividends. A strong financial position can help a firm to pay dividends even when earnings slump.

On this front, Rio Tinto looks pretty robust. Free cash flows fell year over year in the first half but still clocked in at a healthy $7.1bn. The miner also had net cash of $291m sitting on its books.

Trusting dividend yields

Expecting any dividend stock to meet broker forecasts is always a leap of faith. The number crunchers don’t always get it right and estimates can be downgraded as time goes on.

This danger is particularly high for cyclical companies like Rio Tinto. Profits can fluctuate wildly according to broader economic conditions, as analyst projections for 2022 and 2023 show.

Rio Tinto doesn’t offer the stability to income investors of, say, a utilities company, a telecoms business, or a healthcare provider. The essential nature of the services they provide mean profits remain stable at all points of the economic cycle.

Too cheap to miss!

So why did I buy this particular dividend stock, you may ask?

Well I believe that, even if the business fails to meet broker expectations, the dividends it pays out will still beat those of most other UK shares based on yield. Don’t forget that Rio Tinto’s dividend yield is 2.5 times larger than that of the FTSE 100. That leaves a large margin of error.

I also bought Rio Tinto because of its rock-bottom P/E ratio. The miner traded well inside the bargain benchmark of 10 times and below when I bought in. And today its earnings multiple remains super low at just 6.1 times.

In fact, at current prices I’m thinking of buying more Rio Tinto shares. I think it’ll provide excellent returns over the long term as themes like rising urbanisation rates and the green technology boom drive commodities demand.

The post Can I trust Rio Tinto’s 10.3% dividend yield? appeared first on The Motley Fool UK.

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Royston Wild has positions in Rio Tinto. 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.