Rio Tinto Limited (ASX: RIO) shares offer investors a very high dividend yield much of the time. The ASX iron ore share pays one of the largest dividends on the ASX, although there's more to a dividend than just the dollar amount.
Of course, the changing iron ore price can have a major impact on the Rio Tinto share price, the company's profitability, and its profit.
However, as we've seen, even if the iron ore price drops, the company is still able to pay a pleasing dividend yield.
I think it largely comes down to two key reasons.
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Quite high dividend payout ratio
When a company makes a net profit after tax (NPAT), the board has the choice to pay a dividend.
If a business makes $10 of profit and pays a $4 dividend, that's a 40% dividend payout ratio. If it pays $7.50 then it's a payout ratio of 75%. The higher the payout ratio, the higher the dividend yield.
Every business needs to balance the desire to reward shareholders, strengthen its balance sheet, and re-invest for growth.
For Rio Tinto, its target is to return between 40% to 60% of underlying earnings on average through the cycle.
According to the company, it has paid an average of 60% of its profit in ordinary dividends over the past six years. It has also made additional returns, such as special dividends. The average total payout was 74% over the past six years.
Checking Commsec numbers, Rio Tinto is expected to pay out 64.5% of its net profit in FY23, which could result in a forward grossed-up dividend yield of 8.9% with a $7.09 per share dividend. The FY24 payout ratio could be 67.3% according to the $6.48 per share projection, translating into a future grossed-up dividend yield of 8.1%.
However, there is another important factor that can play a large part.
Low earnings multiple
The price/earnings (P/E) ratio has a big influence on the dividend yield.
Rio Tinto typically trades on a low P/E ratio, which means that the Rio Tinto share price is trading at a smaller multiple to its earnings per share (EPS) than other shares such as Commonwealth Bank of Australia (ASX: CBA), which is at a high-teen earnings multiple.
If the P/E ratio goes higher, this will push the dividend yield lower. It's the opposite when the P/E ratio is low – the dividend yield can end up being pretty high.
Utilising Commsec numbers, the Rio Tinto share price is valued at 10 times FY23's estimated earnings and under 12 times FY24's estimated earnings.
If the Rio Tinto dividend stayed the same but the Rio Tino share price doubled, then the dividend yield would be half as high.
Foolish takeaway
Rio Tinto is one of the largest dividend payers, and it's expected to keep it up in the coming years. Copper and lithium could play a bigger role in the company's fortunes in the coming years, but iron could have the biggest influence. Will the iron ore price keep going up? That question could have a major influence on the medium-term outlook for both the Rio Tinto dividend and the Rio Tinto share price.
