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FTSE big hitter Rio Tinto (LSE:RIO) has been through some tough times recently, along with other commodities companies.
The key reason has been China's uneven economic recovery since its Covid years. From the mid-1990s until then it had been the largest buyer of raw materials in the world. Commodities fueled its stellar economic growth.
However, signs of a more sustained recovery are emerging. Last year it registered growth of 5.2%, compared to an official objective of “about 5%”. The same objective remains for this year.
In this sense, on September 24, the largest stimulus measures since the end of the pandemic were announced. These include interest rate cuts and reductions in bank reserve requirements, both aimed at increasing the flow of money into the economy.
They also included direct support for the ailing real estate sector, which alone accounts for about 30% of China's economy.
Passive income potential
In 2023, Rio Tinto paid a total dividend of $4.35, set at a sterling equivalent of £3.4144. On the current share price of £52.96, this gives a yield of 6.4%.
In comparison, the current average FTSE 100 the yield is 3.5% and for the FTSE 250 It is 3.3%.
£9,000 (the same amount I started investing with 30 years ago) would buy 170 shares in the company.
Over a year, these would generate £576 in passive income (money earned with minimal effort, especially, in my opinion, by investing in dividend-paying stocks).
Over 10 years at the same 6.4% return this would rise to £5,760, and over 30 years to £17,280.
The power of dividend compounding
That said, if the dividends were used to buy more Rio Tinto shares, the returns could be much higher. This is “dividend compounding” in financial jargon.
Doing this at the same 6.4% average yield would give a total dividend payment after 10 years of £8,039, not £5,760. And over 30 years on the same basis this would be £52,076 instead of £17,280!
At that point, Rio Tinto's total investment would generate £3,909 a year in passive income, or £326 every month.
My investment vision
I bought the stock recently for three key reasons.
Firstly, it is high performing, which is increasingly important to me now that I am over 50 years old. Such dividend payments should allow me to reduce my work commitments without my lifestyle being unduly affected.
Second, the relative undervaluation of the stock is important. In my experience, this reduces the chances of these dividend gains being negated by share price losses.
On the key price-to-earnings (P/E) measure of share valuation, Rio Tinto is currently trading at just 10.7. This is very cheap compared to its peer group's average P/E of 28.1.
And third, China's much better economic growth prospects are a factor. I think failure to achieve this remains the main risk for Rio Tinto shares.
However, even if China partly misses its expansion target, the absolute gain in terms of monetary trade could still be enormous.
Specifically, even if China achieved “only” 4.5% annual growth, it would be equivalent to adding an economy the size of India to its own every four years.