At the current Fortescue Metals Group Limited (ASX: FMG) share price, a big forecast dividend yield is on offer.
Just take a look at Fortescue's forecast dividend yield, compared to some of its blue-chip peers.
FMG Dividend
At today's prices, Fortescue's dividend yield is greater than that from BHP Billiton Limited (ASX: BHP), Commonwealth Bank of Australia (ASX: CBA) and Telstra Corporation Ltd (ASX: TLS).
Are Fortescue shares a bargain?
At current levels, Fortescue shares have a big dividend of 7.1% and trade at just seven times profit. That's according to analyst forecasts.
However, the important question is not whether Fortescue is a bargain now but whether or not its dividends and profit are sustainable. After all, if you buy shares today you are making a bet on the success of a business tomorrow.
As noted by the bold text above, Fortescue's dividend yield of 7.1% is based on forecasts of profitability and cash flow. To make those forecasts, analysts are required to consider the outlook for commodities, namely iron ore — the only important product Fortescue sells to China.
When Fortescue shares were around $1.50 just 14 months ago — they recently traded as high as $6.88 — analysts were forecasting dire conditions for the iron ore market. After a 100% rally in iron ore prices, the emotion-driven forecast rollercoaster twisted and turned, and everything is peachy once again.
This serves to highlight the difference between an investment in Fortescue and other companies, like Telstra and CBA, in my opinion. Those two companies would make superior alternatives for income-seeking investors — at the right price — because their products are not dictated entirely by market prices.
Buy, Hold or Sell
In my opinion, you must be very careful investing in commodity-type businesses like Fortescue based on the valuation work done by someone else. Over the course of two years Fortescue shares have rallied and its annual dividend has gone from 5 cents per share to a forecast dividend of 45.5 cents per share.
Indeed, if you value Fortescue on the iron ore prices of last year, it is nowhere near as cheap as it appears using today's forecasts.
I'm not a buyer of Fortescue shares because I don't know where iron ore prices will be next month, let alone in a year.
