We recently published a list of 10 Best Australian Stocks To Buy According to Hedge Funds. In this article, we are going to take a look at where Rio Tinto (NYSE:RIO) stands against the other Australian stocks.
A Look at Australia’s Economic Performance in 2024
According to a report by KPMG, the global economy has shown remarkable resilience during monetary policy tightening and ongoing geopolitical tensions. In contrast, the Australian economy was close to entering a recession in 2024, with a mere 0.1% growth in the first quarter. Over the past year, the economy grew by only 1.1%. Household consumption increased by 0.4% during Q1, slightly better than Q4 of 2023. However, labor productivity, measured as GDP per hour worked, remained stagnant as the growth in hours worked matched GDP growth. The mining sector plays a crucial role in the economy of Australia making up 14.3% of the industry’s output, while finance contributes 7.4%, and manufacturing and construction add 7.1% and 5.7%, respectively. Australia’s export market is primarily driven by its mining resources, with China being the largest destination, accounting for 32.4% of exports, followed by Japan at 13.1%.
The March 2024 survey of private capital expenditure reveals strong actual investments in the first nine months of FY24, along with positive momentum for the remainder of the financial year and into FY25. Private new capital expenditure rose by 1% in the March quarter of 2024. Business investment in non-mining industries grew by 3.3%, partially offsetting a 4.7% decline in mining capital expenditure. This quarterly growth marks a slowdown from the robust levels seen in late 2022 and early 2023. The transport, postal, and warehousing sectors experienced the strongest growth, driven by increased vehicle investments and ongoing spending on large infrastructure projects. Similarly, capital expenditure on equipment and machinery in the information media and telecommunications sector rose significantly due to continued investment in data centers. However, the weakening demand for consumer goods and services impacted the retail sector and its upstream industries.
Australian Equities vs. U.S. Stocks
Chris Leithner, joint managing director at Leithner & Co. investment company, is bullish on Australian equities and expects the market to outperform the S&P 500’s returns in coming years. According to him, over the past decade and more, the total returns of the All Ordinaries and ASX 200 indexes, have underperformed the S&P 500 Index. Some analysts, such as Roger Montgomery, attribute this underperformance to Australian companies’ overly generous dividend payments, inadequate earnings retention, and restricted capital expenditure. However, Leithner disagrees and says that a significant factor of this underperformance is the difference in earnings growth between the two markets. American stocks have benefited from substantial earnings growth, partly driven by debt-financed share buybacks, leading to higher debt-to-equity and CAPE ratios. In contrast, Australian equities have experienced a decline in CPI-adjusted earnings per share (EPS), as share buybacks have not played the same role. As a result, Australian companies are more conservatively financed and offer superior medium and long-term prospects. This analysis suggests that while American equities have generated significant rewards since the Global Financial Crisis (GFC), they also pose considerable risks at current prices. Conversely, Australian equities, despite their recent underperformance, are better positioned for future growth due to their robust financial foundation and conservative pricing.
Share buybacks have dramatically increased over the years, with S&P 500 companies repurchasing a staggering $825 billion worth of stock in the 12 months leading up to January 2024. This is part of a broader trend that has seen buybacks rise from an average of around $200 billion per year in the early 1990s to over $1 trillion per year before the COVID-19 pandemic. While buybacks can boost earnings per share (EPS) by reducing the number of shares outstanding, they also artificially inflate the growth of earnings. For instance, a company that repurchases shares can show a much higher EPS growth rate than its net profit after tax growth rate. While this inflation of earnings through buybacks is significant, research suggests that buybacks have contributed between 30-40% of the long-term EPS growth of the S&P 500, with some estimates as high as 71%. The cumulative effect of these repurchases is immense, with S&P 500 companies buying back a CPI-adjusted total of $17.7 trillion worth of shares since 1990, an amount equivalent to nearly 45% of the current U.S. GDP.
The leverage used to finance these buybacks is also noteworthy. In contrast to Australian companies, which have a relatively low debt-to-equity ratio and conduct minimal buybacks, U.S. companies have significantly increased their leverage over the past two decades, with the debt-to-equity ratio surpassing above 80% in recent years. This increased leverage, coupled with the substantial buybacks, has led to a higher cyclically adjusted price-to-earnings (CAPE) ratio for the S&P 500 compared to the All Ordinaries Index in Australia. As a result, while the S&P 500 has outperformed the All Ords in recent years, the high CAPE ratio suggests that future returns for the S&P 500 may be lower, while the Australian shares may offer better medium- to long-term prospects.
According to IG’s biannual Client Sentiment Survey, Australian traders are bullish towards the S&P/ASX 200, with 65% expecting a rise in the next six months. Despite this confidence, there is a noticeable shift towards international markets, particularly in the United States, where many traders believe the Nasdaq will outperform the ASX 200. Australian traders have nearly doubled their focus on US markets over the past six months. International markets provide exposure to a broader range of industries, especially in technology and growth stocks, and offer opportunities for risk management and enhanced returns. Australia’s market lacks diversity, by fostering innovation and supporting emerging industries the market could attract more local investment.
While the global economy demonstrates resilience, Australia’s economic performance in 2024 has been less robust. The mining sector continues to be a key driver, alongside finance and infrastructure investments, but the broader economy faces challenges, particularly in retail and upstream industries. However, the outlook for the remainder of FY24 and into FY25 remains cautiously optimistic, with private capital expenditure showing some positive momentum. With that in context, let’s take a look at the 10 best Australian stocks to buy according to hedge funds.
Why do we care about what hedge funds do? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
Aerial view of an open pit mine, with workers extracting minerals.
Rio Tinto (NYSE:RIO)
Number of Hedge Fund Holders: 29
Market Capitalization as of August 30: $79.31 Billion
Rio Tinto (NYSE:RIO) is a global mining group specializing in the extraction and production of minerals and metals. The company business model is well-diversified across various segments, reducing dependency on any single commodity. Rio Tinto (NYSE:RIO) operates in over 35 countries and produces iron ore, copper, aluminum, critical minerals, and other materials essential for the global energy transition.
In the first half of 2024, iron ore was the major revenue driver for Rio Tinto (NYSE:RIO) and accounted for 53% of its total revenue, the company’s diversification into aluminum and copper represents 37% of its revenue. This diversification mitigates risks associated with iron ore price fluctuations and allows the company to leverage growth opportunities in other metals, particularly as demand for aluminum and copper is set to increase significantly. According to a report by the World Bank, aluminum and copper prices are forecasted to increase modestly by 2% and 4%, respectively by 2025.
According to Forbes, the demand for aluminum is expected to grow by 50% by 2050 driven by the rise of electric vehicles (EVs) and renewable energy infrastructure. Copper demand is forecasted to increase by 75% by 2050. The company’s Resolution project in Arizona can produce as much as 40 billion pounds of copper over 40 years. Rio Tinto’s (NYSE:RIO) key projects, such as the Oyu Tolgoi underground copper mine in Mongolia, the La Granja copper project in Peru, and the AP60 aluminum smelter expansion in Canada, are expected to enhance the company’s production capabilities and positions it well to capitalize on the growing demand and offers reliable revenue streams in the coming years. Economic growth in regions such as India is also expected to contribute to iron ore demand.
Despite short-term challenges, including declining iron ore prices, Rio Tinto’s (NYSE:RIO) strategic diversification and favorable long-term demand for metals, make it a compelling investment opportunity for those looking to capitalize on future growth in the mining sector. Rio Tinto (NYSE:RIO) is trading 8.59 times its earnings, which is a 46% discount compared to the sector median of 15.91. In the second quarter, Rio Tinto’s (NYSE:RIO) stock was held by 29 hedge funds with stakes worth $1.29 billion. Fisher Asset Management is the largest shareholder in the company with a stake worth $1.12 billion as of June 30. Industry analysts have a consensus on the stock’s Buy rating, setting an average share price target at $81.88, which represents a 25.64% upside potential from its current level.
Overall RIO ranks 3rd on our list of the best Australian stocks to buy according to hedge funds. While we acknowledge the potential of RIO as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than RIO but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure. None. This article is originally published at Insider Monkey.