Rio Tinto Plc’s stock price has surged to a price of $64.37 today. With their 3.2% increase, RIO shares outpaced both the S&P 500 and Dow Industrial composite indices by 1.0%, but are still well below their 52 week high of $80.52. Over the last 12 months, Rio Tinto Plc is up 20.0%, and has outperformed the S&P 500 by 0.0%. Now, the large-cap Basic Materials company is 22.6% below its average target price of $83.17 and has an average analyst rating of buy.
Rio Tinto Plc's trailing 12 month price to earnings (P/E) ratio is 12.2, which is its share price divided by its trailing earnings per share (EPS) of $5.27. The company has a forward P/E ratio of 15.3 based on its forward EPS of $4.21 -- which is an estimate of future earnings provided by management. The P/E ratio tells us how much investors are willing to pay for each dollar of the company's net earnings from its sales operations. By way of comparison, the average P/E ratio of the Basic Materials sector is 10.03, but a company's price can remain stable for a long time even if it is over or undervalued.
Company accountants calculate earnings by subtracting the costs of sales and overhead from its revenues. These metrics focus on the sales side of the company only -- it's important to remember that companies can have many other costs and sources of income that are independent from its core business. For example, a company may have extensive expenses such as rent and debt servicing, and on the other hand it may receive additional income from its investments and intellectual property.
So the earnings picture only shows a slice of the company's financial health. They also don’t represent actual inflows of cash, since revenues are calculated on the basis of product or service deliveries, as opposed to actual payments received. The importance of earnings is that they enable us to analyze the company’s growth and profitability over time.
Here is an overview of Rio Tinto Plc’s operating margins, which are the percentage of net profit compared to total revenues:
| Date Reported | Total Revenue ($ k) | Operating Expenses ($ k) | Operating Margins (%) | YoY Growth (%) |
|---|---|---|---|---|
| 2021-01-01 | 44,611,000 | -624,000 | 40 | 14.29 |
| 2020-01-01 | 43,165,000 | -614,000 | 35 | 12.9 |
| 2019-01-01 | 40,522,000 | -11,578,600 | 31 | -3.12 |
| 2018-01-01 | 40,030,000 | -11,560,000 | 32 | 68.42 |
| 2017-01-01 | 33,781,000 | -11,728,000 | 19 | 11.76 |
| 2016-01-01 | 34,829,000 | -11,939,000 | 17 |
- Average operating margins: 29.0 %
- Average operating margins growth rate: 15.2 %
- Coefficient of variability (the lower the better): 31.4 %
Let’s contrast the operating margins with an overview of Rio Tinto Plc’s gross margins, which only take into account expenses directly related to producing revenue (i.e. without overhead):
| Date Reported | Revenue ($ k) | Cost of Revenue ($ k) | Gross Margins (%) | YoY Growth (%) |
|---|---|---|---|---|
| 2021-01-01 | 44,611,000 | -26,254,000 | 41 | 10.81 |
| 2020-01-01 | 43,165,000 | -27,307,000 | 37 | -37.29 |
| 2019-01-01 | 40,522,000 | -16,559,000 | 59 | -3.28 |
| 2018-01-01 | 40,030,000 | -15,807,000 | 61 | 12.96 |
| 2017-01-01 | 33,781,000 | -15,530,000 | 54 | 3.85 |
| 2016-01-01 | 34,829,000 | -16,819,000 | 52 |
- Average gross margins: 50.7 %
- Average gross margins growth rate: 0.1 %
- Coefficient of variability (the lower the better): 19.1 %
An alternative form of measuring a company's valuation is to focus on its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. Book value represents the amount of money that would be available to equity holders if the company were to sell all of its assets and pay off all of its debts today. Rio tinto plc's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 2.0, indicating the company may be undervalued compared Basic Materials sector’s average P/B ratio of 2.08.
RIO's average free cash flow over the last few years is $18.25 Billion, which represents the sum of inflows and outflows of cash from all sources, including capital expenses.. This is the pool of liquidity that the company can use to reinvest in its business or pay out to its equity investors in the form of a dividend. Over the last twelve months investors in Rio Tinto Plc have enjoyed a dividend yield of 6.4%.
Since it has a an inflated P/E ratio, an average P/B ratio, irregular cash flows, and decent operating margins, Rio Tinto Plc is probably overvalued at current prices. Make sure to complement this brief quantitative review with a qualitative analysis of your own!
