Is it time to DROP your Rio Tinto Limited shares?

Warren Buffett has two fundamental rules when he goes about investing. They are:

Rule #1: Don’t lose money.

Rule #2: Never forget rule number one.

It’s easier said than done and I bet the punters who took a gamble on a rebounding iron ore price earlier this year would be sitting on hefty losses. Rio Tinto Limited (ASX: RIO), Australia’s biggest iron ore miner, is already down 10% in 2014.

So do you sell now and take your losses off the table? Or is it an opportunity to buy more?

Whilst no one can accurately predict the short share price fluctuations of a company such as Rio, there are a few things potential investors and shareholders need to understand.

Firstly betting against the hordes of analysts, official government forecasters and the world’s biggest investment banks by expecting iron ore to rebound in the next few years is unlikely to play out well. Analysts are expecting an average iron ore price of $US80 per tonne in the next two years, which is significantly down from 2014’s opening price about $US135 per tonne. The iron ore commodity super cycle is very long and could be very costly for miners (and their shareholders) who do not react accordingly.

Iron ore accounted for over 90% of Rio’s FY13 earnings. However Rio has a high grade ore, unlike Fortescue Metals Group Limited (ASX: FMG) and CEO Sam Walsh believes his company is, “The lowest-cost producer in the world,” with costs of around $US20 per tonne. That’s even lower than the costs of the mighty BHP Billiton Limited (ASX: BHP).

Outside of iron ore, Rio’s copper division is expected to boost production in the next two years and Mr Walsh hasn’t ruled out an acquisitive expansion into the commodity. Its Aluminium division, the miner’s long-term destroyer of shareholder wealth, has recently taken tough measures to improve margins and profitability, this division could surprise the market with higher earnings in coming years.

Lastly, Rio has written-off tens of billions of dollars in shareholders’ money over the past five years across its Aluminium, Energy (coal and uranium) and Copper divisions. If this ends, Rio’s shares (and profit) will jump significantly.

Buy, Sell or Hold?

Rio has long-term potential but I’m not 100% convinced the effects of a falling iron ore price are baked into its current share price. I’m waiting for the half-year reports next month or, at least, the operations review due out in two weeks.

Whilst I'm concerned about the effects of iron ore on Rio's balance sheet, there's one ASX dividend stock with a 7% grossed-up payout, I'm considering buying instead. Our top analyst recently dubbed it, "The Motley Fool's Top ASX stock for 2014 - 2015". You can click here to download your free copy of "The Motley Fool's Top Dividend Stock for 2014-2015" today.

Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies. 

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