170 shares in this overlooked FTSE heavyweight can make you £3,909 a year in passive income!

FTSE a big hitter Rio Tinto (LSE: RIO) has had a tough time of it recently, along with other commodity sectors.

A key reason has been China's uneven economic recovery since its Covid years. From the mid-1990s to that point it had been the world's largest consumer of goods. Commodities have fueled phenomenal economic growth.

However, signs of continued recovery are emerging. Last year it recorded a growth of 5.2% – compared to the official target “about 5%”. The target remains the same this year.

Meanwhile, the 24th of September saw the biggest recovery measures announced since the end of the pandemic. These include interest rate cuts and reductions in bank reserve requirements – both aimed at increasing money flowing into the economy.

They also showed direct support for the ailing construction sector, which accounts for about 30% of China's economy.

Income opportunities

In 2023, Rio Tinto paid a dividend of $4.35, a dividend equal to £3.4144. At the current share price of £52.96, this gives a yield of 6.4%.

By contrast, the current ratio FTSE 100 yield 3.5% and for the FTSE 250 it is 3.3%.

£9,000 – the same amount I started investing with 30 years ago – would buy 170 shares in the company.

Over the course of a year, these will generate £576 in income (money made with little effort, especially in my opinion by investing in dividend paying stocks).

Over 10 years at the same 6.4% yield, this would rise to £5,760, and over 30 years to £17,280.

Dividend compounding power

That said, if the dividends were used to buy more Rio Tinto shares, the return could be much higher. This is 'dividend compounding' in financial parlance.

Doing this with the same yield of 6.4% would give total repayments after 10 years of £8,039, not £5,760. And over 30 years on the same basis, this would be £52,076 rather than £17,280!

Meanwhile, Rio Tinto's total investment will generate £3,909 a year in income, or £326 a month.

My investment idea

I bought the stock recently for three main reasons.

First, it has a high yield, which is increasingly important to me now that I am over 50 years old. Such dividend payments should enable me to reduce my work obligations without my lifestyle being unduly disrupted.

Second, the relative undervaluation of stocks is important. This reduces the likelihood that these dividend gains will be wiped out by a loss in share price, in my experience.

On the key price-to-earnings (P/E) ratio for stock valuation, Rio Tinto currently trades at just 10.7. This is very cheap compared to the 28.1 P/E ratio of its competitor.

Third, China's highly developed economic growth prospects are a factor. Failure to realize this remains the biggest risk for Rio Tinto shares, I think.

However, even if China partially reduces its expansion target, the net gain in terms of trading capital would still be large.

Specifically, even if China manages 'just' 4.5% annual growth, it would be equivalent to adding an economy the size of India to its own every four years.