RIO Shares Fall -3.8% Today -- Is This an Opportunity or Value Trap?

Standing out among the Street's worst performers today is Rio Tinto Plc, a industrial metals & mining company whose shares slumped -3.8% to a price of $54.76, 22.62% below its average analyst target price of $70.77. The average analyst rating for the stock is buy. RIO underperformed the S&P 500 index by -3.4% during today's afternoon session, but outpaced it by 4.9% over the last year with a return of -11.8%.

Rio Tinto Group engages in exploring, mining, and processing mineral resources worldwide. The company belongs to the basic materials sector, which includes the chemical, coal, mining, aluminum, and steel industries. The demand for these materials is dependent on economic cycles: when the economy is growing, companies across all sectors ramp up production, which increases demand from basic materials companies.

Conversely, when the economy slows down, demand for these materials decreases. The stock prices of this sector tend to follow the ebbs and flows of these demand cycles -- but accurately predicting where we are presently in the economic cycle is a matter of intense debate.

Rio Tinto Plc's trailing 12 month P/E ratio is 5.0, based on its trailing Eps of $10.86. The company has a forward P/E ratio of 13.0 according to its forward Eps of $4.21 -- which is an estimate of what its earnings will look like in the next quarter. As of the third quarter of 2022, the average Price to Earnings (P/E) ratio for US basic materials companies is 8.57, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.

To understand a company's long term business prospects, we must consider its gross profit margins, which is the ratio of its gross profits to its revenues. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost. After looking at its annual reports, we obtained the following information on RIO's margins:

  • 2021 gross margins: 49.4 %
  • 2020 gross margins: 41.9 %
  • 2019 gross margins: 37.5 %
  • 2018 gross margins: 35.0 %
  • Average gross margin: 41.0 %
  • Average gross margin growth rate: 12.2 %
  • Coefficient of variability (higher numbers indicating more instability): 15.3 %

We can see from the above that Rio Tinto's gross margins are very strong. Potential investors in the stock will want to determine what factors, if any, could derail this attractive growth story.

To deepen our understanding of the company's finances, we should study the effect of its depreciation and capital expenditures on the company's bottom line. We can see the effect of these additional factors in Rio Tinto's free cash flow, which was $17,961,000,000.00 as of its most recent annual report.

Over the last 4 years, the company's average free cash flow has been $10,865,500,000.00 and they've been growing at an average rate of 45.2%. With such strong cash flows, the company can not only re-invest in its business, it can afford to offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in RIO have received an annualized dividend yield of 11.9% on their capital.

Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts). Rio tinto's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 1.8, but is still below the average P/B ratio of the Basic Materials sector, which stood at 1.86 as of the third quarter of 2022.

Since it has a very low P/E ratio, a lower P/B ratio than the sector average, and a steady stream of strong cash flows with an upwards trend, Rio Tinto is likely undervalued at today's prices. The company has mixed growth indicators because of no published PEG ratio and consistently strong gross margins that are increasing. We hope you enjoyed this overview of RIO's fundamentals. Be sure to check the numbers for yourself, especially focusing on their trends over the last few years.

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The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.