Rio Tinto Limited (ASX: RIO) has seen its share price fall more than 13% since early October and has now lost 45% of its value since November 26, 2010 – five years ago.
Year-to-date, shareholders are looking at a 21% fall.
Shares are now trading at close to five-year lows. If it wasn't for the Global Financial Crisis, it could've been the lowest price in a decade.
Who wants to buy shares in a company when they will be worth roughly half what you paid for them in five or ten years' time?
No-one that's who. But should you sell your shares now and take what you can get or even buy more?
Some analysts and market commentators are arguing that the current share price might be a bargain price to pay for Rio. In fact, Reuters shows that 10 out of 18 analysts still think Rio is a Buy.
Mind you, those 10 analysts have probably recommended investors buy Rio shares for the past five years (look where that would've got them).
That unfounded optimism is despite earnings per share (EPS) expected to almost halve this financial year and drop again next year. In the 2014 financial year (FY14), Rio made US$5.03 in underlying EPS – but Rio's financial year ended in December 2014 when the iron ore price averaged US$68.80 per tonne. Today, it's trading at US$44.50 per tonne and likely to head lower.
That's an important point to make about Rio because the miner generates 88% of earnings from the commodity. With an iron ore price down 50% so far this year, earnings for the FY15 year are likely to be much lower. In fact, for the six months to June 2015, Rio saw earnings drop 43% and underlying EPS down the same percentage. The second half is likely to be even worse as the iron ore price keeps falling.
No wonder Reuters has consensus forecast earnings of US$2.58 for this financial year (FY15) and US$2.31 for FY16. That equates to around A$3.58 and a prospective P/E ratio of 12.8x.
The problem with lower earnings is that price generally follows earnings. If earnings continue falling, Rio's share price is likely to head even lower (and yet the analysts still have their heads stuck in the sand).
Forget the monster dividend yield too. That won't cover the potential capital losses and is likely to be cut as earnings fall.
What Rio really needs is a recovery in the iron ore price, but that appears unlikely. Some commentators have suggested we could see persistently low commodity prices for many years. With Rio so dependent on iron ore for earnings, the company is virtually at the mercy of the commodity price. Where it goes, so do will Rio's share price, and I could see a price of between US$20-US$30 a tonne as possible.
No one could've imagined BHP Billiton Limited's (ASX: BHP) share price plunging to ten-year lows and below $25 not long ago, let alone trade at just above $18. But that's where it is and Rio could be headed for a similar fate.
Foolish takeaway
Having destroyed shareholder value in the past 10 years despite a resources boom and iron ore prices at record levels, Rio's share price looks headed even lower and could stay there for many years, until or if iron ore prices recover. Investors might want to give Rio a wide berth, existing shareholders should consider looking elsewhere.
