FTSE 100 metals and mining giant Rio Tinto (LSE: RIO) has a long history of paying very good dividends.
Working back five years from 2022, it paid 7.7%, 15.5% (including a special dividend), 7.5%, 7.8%, and 11.2% (another special dividend included).
Each was well-supported by dividend cover ratios of just over 1.6. Above 2 is considered good, while below 1.5 indicates the risk of a dividend cut.
The total dividend for 2022 was 407p. This gives a yield of 7.7% based on the current £52.99 share price.
At this price, just under £10,000 would buy me 188 shares in the firm.
The magic of dividend compounding
Stock dividend compounding involves reinvesting dividends back into the stocks that pay them.
The difference in gains between withdrawing dividends paid each year or reinvesting them is huge.
For example, my 7.7% dividend return on £10,000 of Rio Tinto shares would make me £770 in the first year.
If I withdrew that, I would receive another £770 the following year, provided the dividend remained the same. If I repeated the process, I would have made £23,100 after 30 years.
However, if I reinvested the dividends into Rio Tinto stock, I would have £92,570 after 30 years, given the same average yield. That would pay me £6,618 a year in passive income, or £552 each month!
A regular investment bonus
If I wanted to boost these returns, I would continue to save and invest. Another £500 a month put into 7.7%-yielding Rio Tinto stock would provide the same £552 a month income after just eight years.
After 30 years, I would have a minimum investment pot of £805,830, given the same yield. This would pay me £59,331 a year in passive income, or £4,944 every month.
Inflation would affect the buying power of my income. But it underlines how big returns can be made from much smaller investments, if the dividends are compounded.
Will I buy the stock?
I have other stocks in the commodities sector, so buying another would unbalance my portfolio.
If I did not have these, I would buy Rio Tinto stock today. The key risk in the shares, of course, is if China’s economy fails to recover fully after three years of Covid.
Before Covid hit at the end of 2019, China’s economic boom from the mid-1990s supported consistent rises in commodities prices.
In 2023, many analysts doubted whether it would achieve its economic growth target of “around 5%”. However, it exceeded this target — posting 5.2%.
“Around 5%” is the target again for this year. And China has introduced several economic stimulus measures to ensure it is met.
This should provide a positive operating environment for Rio Tinto.
Its Q4 2023 production update showed mined copper production up 5% year on year. Copper is extensively used in China’s infrastructure developments.
Aluminium production increased by 8% over the same period — this is widely used in China’s manufacturing of vehicles, electronics, and consumer goods, as well as in construction.
The company also remains a key player in the lithium market, essential in China’s rechargeable battery industry.
Analysts’ expectations are that its earnings will rise by 7.5% a year to end-2026. Return on equity is predicted to be 19.7% by the same year.
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Simon Watkins has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
