The iron ore price has fallen 15% in 2 weeks. So, is the Rio Tinto share price a buy or sell?

Is the allure of big dividends enough to buy Rio Tinto shares today?

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Key points

  • Rio Tinto, one of Australia’s biggest iron ore miners, is generating large profits and paying significant dividends
  • The business benefits from higher iron ore prices – although I’m not sure if today is the right time to buy because iron demand is subject to change
  • However, Macquarie and Morgan Stanley both think Rio Tinto is a buy

The Rio Tinto Limited (ASX: RIO) share price is an interesting investment proposition. The iron ore price has been falling – it’s down 15% in two weeks.

So, does a lower iron ore price mean that Rio Tinto shares are more attractive or less attractive?

Why higher iron are prices are good

As a commodity business, Rio Tinto generates revenue and profit largely by mining resources and selling them to customers.

The higher the commodity price, the better revenue, cash flow, and net profit after tax (NPAT) for the business.

Those bigger financial numbers can also lead to much bigger shareholder payouts in the form of dividends.

So, it’s clear that current, ongoing shareholders would want commodity prices to be higher so that they can boost profit and returns.

Certainly, new investors who buy today can benefit from big dividends while commodity prices are high and cash flow is rolling in.

In Rio Tinto’s FY21 full-year result, it reported that its NPAT rose by 116% to US$21 billion, free cash flow increased 88% to US$17.7 billion, and the total annual dividend was increased by 87% to US$10.40 per share.

But the tricky part for investors is deciding when to buy new shares. Does a lower iron ore price make the Rio Tinto share price more attractive?

My thoughts on the right time to buy Rio Tinto shares

Commodities such as iron ore often work in cycles because of the relationship between supply and demand. Both supply and demand can shift quite a bit during economic cycles.

Sometimes global/Chinese demand for iron ore will reduce and we just don’t know when that will be.

When the iron price falls, the market reduces its profit expectations and then the Rio Tinto share price normally declines. We saw this in 2016 and towards the end of 2021.

Dividends are a good part of the returns, but a 10% decline in the Rio Tinto share price can wipe out the monetary gains of receiving a 10% dividend yield. So, it’s not just about the dividend. I think total returns should be the goal.

I will also point out that some brokers currently rate Rio Tinto as a buy, including Macquarie and Morgan Stanley. The Macquarie price target is $135, implying a possible upside of around 30%, with the broker liking the stronger-than-expected iron ore price which can help profit generation.

It’s impossible to predict when commodity prices and share prices are going to move but I think that when the iron ore price sizeably moves, the Rio Tinto share price is likely to follow it. Since 8 June 2022, the Rio Tinto share price has fallen more than 11%. The share price is now close to the 2022 low.

Foolish takeaway

So, my conclusion is that it’s better to look at Rio Tinto when the share price has fallen significantly along with the iron ore price. I don’t have a crystal ball to know if or when iron ore prices will go below US$100 per tonne or US$90 per tonne, but that’s the sort of level that I’d be looking at the Rio Tinto share price for my own portfolio.

However, I do like that the ASX mining share is exposed to a number of commodities. That means it’s not reliant on just iron ore with assets in aluminium, copper, titanium dioxide, and lithium.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Macquarie Group Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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