Look at that dividend! Is Fortescue Metals Group Limited a bargain at this share price?

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

Source: Google Finance

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.

A Big, Fat, Fully Franked Dividend

This company's dividend is almost the stuff of legends. Since it started paying dividends in 2007, it has increased its payout to shareholders every single year, a run that includes 21 consecutive dividend increases.

Based on the last 12-months of dividends, its shares are currently offering a fully-franked 4.8% yield, which grosses up to almost 7% when those franking credits are included. And in stark contrast to the likes of Commonwealth Bank and Telstra, this company just increased its dividend by over 13%, and guided for 2017 profits to grow by 20%!

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Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any company mentioned. Owen encourages your feedback. You can follow him on Twitter @OwenRask.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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