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Are Rio Tinto shares worth snapping up with a 12.5% dividend yield?

Young Black woman looking concerned while in front of her laptop
Young Black woman looking concerned while in front of her laptop

For income investors like myself, it’s hard to ignore Rio Tinto (LSE:RIO). Although I don’t own the stock directly, a fund I’ve invested in does hold Rio Tinto shares. Largely due to the 12.5% dividend yield, it appears to be a no-brainer for passive income potential. With the yield climbing for most of 2022, should I buy the stock before year end?

Not all as it seems

To calculate the dividend yield, I divide the current share price by the latest dividend per share. For the yield to increase, either the share price needs to fall or the dividend per share needs to grow. It’s important to figure out which is the case for Rio Tinto, as it makes a difference.

Over the past six months, the share price is down 13.6%, but it’s up by 3.8% over a longer one-year time period. This year, the sum of the interim and final dividend payments was $6.84. This was pretty much the same as the previous year’s $6.85. I’ve excluded special one-off dividends from these calculations.

What this tells me is that the dividend payments are stable, but the reason for the dividend yield increase in recent months is mostly down to the share price falling. This is a little more concerning to me as it could indicate that the business might be starting to struggle.

Reasons for Rio Tinto shares falling

Q3 production results were a real mixed bag, with iron ore production flat, aluminum down 7%, but copper up 8%. Going forward, the full-year production guidance was reduced slightly on concerns around a global economic slowdown.

Further, I think it’s incredibly hard to predict where commodity prices will go over the next year. Some of the fall in the share price reflects not only the recession fears, but also the uncertainty of future metal demand.

Income payments still attractive

Yet even if financial results moderate in coming quarters, I still believe the stock is worth me considering for dividend income. I’m confident of future payouts based on the current dividend coverage ratio. This measures whether the current earnings per share can meet the dividend per share payment.

At the moment, the dividend cover is 1.62. This is comfortably above 1, highlighting that even if future earnings fall slightly, the current level of income payout shouldn’t be materially under threat.

I also think it’s worth bearing in mind that the yield of 12.5% makes it the second-highest in the entire FTSE 100. If the yield was 3%-5%, I’d probably conclude that the volatile commodity price outlook isn’t worth the risk when the yield isn’t that juicy. Yet with such a high reward, I’m naturally going to have to accept a larger amount of risk. That’s simply how the stock market works.

Despite concerns around the recent share price wobble, I’m looking to invest a small amount in Rio Tinto shares shortly.

The post Are Rio Tinto shares worth snapping up with a 12.5% dividend yield? appeared first on The Motley Fool UK.

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Jon Smith 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.

Motley Fool UK 2022