Is Fortescue stock's 8% dividend yield worth the risk?

Is the payout large enough to compensate for the lurking danger?

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Owning Fortescue Ltd (ASX: FMG) stock has been very rewarding in terms of dividends over the last few years. It's impossible to know what's going to happen next in the resources world, but it's hard to imagine the FY25 payout will be as good as we've seen over the last few years.

Fortescue's dividend in FY24 was lower than FY22 and significantly lower than FY21. Its payment is dictated by the net profit made because Fortescue is committed to a dividend payout ratio – it pays out a certain percentage of its profit generated.

If the profit falls, then so does the dividend payment. The opposite is true in the good times – the dividend can soar.

However, we're certainly not in the good times right now. Thus, investors may think it's risky to buy Fortescue shares. The Fortescue stock price is down 40% in 2024 to date.

Firstly, let's look at how much dividend income the ASX mining share may pay in FY25.

Dividend forecast

The ASX iron ore share is forecast (using Commsec figures) to pay an annual dividend per share of $1.04 in FY25, representing a projected dividend payout ratio of 57%.

At the current Fortescue stock price, this forecast represents a fully franked dividend yield of 6% and a grossed-up dividend yield of 8.5%.

The broker UBS is more pessimistic – it thinks Fortescue is going to more than halve its annual payout to just 90 cents per share in FY25. That would be a grossed-up dividend yield of 7.4%.

If we take the average of those two projections, it works out to around 8%, grossed up for franking credits.

Is this the right time to invest in Fortescue stock?

According to Trading Economics, the iron ore price has fallen from above US$140 per tonne at the start of the year to almost US$90 per tonne now. Considering Fortescue's mining costs are now similar to what they were at the start of the year, Fortescue's monthly profit generation has been significantly reduced.

Ultimately, the commodity decline is due to a weakening in the supply and demand situation, namely a reduction of demand from China.

More recently, disappointing economic data from China has hurt sentiment, according to Trading Economics. In August, Chinese industrial output, retail sales, and fixed asset investments missed forecasts.

Trading Economics also said that the urban unemployment rate also rose to a six-month high, while home prices reportedly fell at the fastest pace in nine years.

Amid this environment, the Fortescue dividend is forecast to reduce further in FY26. The Commsec number suggests the annual payout could be 80 cents per share, while UBS estimates the annual payout could be 79 cents per share in FY26.

Of course, it's this weak environment that has created the low Fortescue stock price of under $18 that we're seeing today.

I think this is the time to consider Fortescue stock. Resources are typically cyclical, and when the weakness seems like it's here to stay, we can get the best prices.

However, I'm not expecting the iron ore price to recover to former highs. Major miners are talking about increasing production in the next few years, which could limit the recovery.

The key will be whether Chinese demand can bounce back, which is very difficult to judge, particularly given that the Asian superpower seems cautious about trying to stimulate the economy.

I think Fortescue stock could be a higher-risk medium-term buy, but the current lower price has reduced the risks somewhat.

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Motley Fool contributor Tristan Harrison has positions in Fortescue. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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