Fortescue Metals Group Limited (ASX: FMG) shares pay a very high dividend yield to investors. But how is the ASX iron ore share managing to do this?
Fortescue is one of the largest iron ore miners in the world with a market cap of $62 billion, according to the ASX.
It's a bit bigger than it was a few weeks ago. The Fortescue share price is up over 20% in the last two months.
Fortescue is known for its large dividend payouts to shareholders. Not just in dollar terms, but also in terms of the dividend yield.
Another big dividend is expected in FY23 according to CommSec, with a projected payout of $1.41 per share. This translates into a forward grossed-up dividend yield of 10% at the current Fortescue share price.
How is the business managing to pay such a good dividend while investing in its green energy endeavours? I think it mainly comes down to two things.
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High dividend payout ratio
The more of a company's net profit after tax (NPAT) it pays out as a dividend, the bigger the dividend yield.
Fortescue has a dividend policy of having a dividend payout ratio of between 50% and 80% of its NPAT.
In FY22 it paid an annual dividend per share of $2.07 per share, representing a dividend payout ratio of 75%.
Using the estimates on CommSec for FY23, the ASX iron ore share is expected to have a dividend payout ratio of 70.8%.
This means there is still plenty of cash left for Fortescue to put some of the retained profit into its green hydrogen goals and some into funding mining-based growth for the business.
Low earnings multiple
It's important to know that even if two businesses have the same dividend payout ratio, they can have different dividend yields, because the valuation of the business is different.
The higher the price-to-earnings (p/e) ratio, the lower the dividend yield. This works in the opposite way as well, when the p/e ratio is lower, it boosts the dividend yield. But, a low p/e ratio doesn't necessarily mean it's good value or a reliable business.
Fortescue usually has a low p/e ratio, naturally boosting the dividend yield. Iron ore prices can be volatile, so miner earnings aren't expected to be consistent year to year. In the good times, the iron ore miner makes tons of profit, and the p/e ratio is typically low. When the iron ore price is low Fortescue shares can sometimes trade on a higher p/e ratio.
According to CommSec, the Fortescue share price is valued at 10x FY23's estimated earnings.
Foolish takeaway
The Fortescue dividend yield could remain high for at least the next 12 months. If the iron ore price remains above US$100 per tonne, Fortescue could continue to pay good dividends in the medium term. However, investors may be able to grab an even higher dividend yield if they can jump on Fortescue shares when it goes through a significant dip.
