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Rio's wake-up call for investors

Well, colour me surprised. A mining company that favoured scale over discretion has got itself into trouble by overpaying – again.

The company in question – and in the headlines – is Rio Tinto (ASX: RIO), which has lost its chief executive, Tom Albanese, by "mutual agreement" with the board.

We don't know how the conversation went down, but you can imagine there weren't a lot of words necessary when as chief executive you recommended that the board approve the second multi-billion-dollar write-down in quick time.

My guess is that Albanese was already mentally preparing to pack up his office and clean out his desk before he even finalised the numbers.

(How boards of directors manage to survive when chief executives are dumped is something of a modern mystery. They approve the company strategy and large acquisitions, after all, so the buck stops also with them.)

When bad news is good news


Ironically, Rio Tinto's share price opened up a couple of percentage points this morning – likely because investors were happy that the problem wasn't worse. Some may be happy that Albanese was leaving the big Anglo-Australian miner.

Mining is a traditionally tough business. You're selling a commodity product, you have essentially no pricing power, and new supply is being found all the time. It's no wonder many "hopefuls" go broke.

It's also an industry of "big bets". Boards and chief executives see scale as a path to relative prosperity, and for companies such as Rio and BHP Billiton (ASX: BHP), there are only a small number of deals that can really move the dial, given their gargantuan size.

Of course, Albanese and Rio could have been prescient – or just plain lucky – and the deals might have been bargains in hindsight, but clearly the required level of certainty wasn't there at the time, and the deals were obviously riskier than they should have been.

Damned if you do …

If you've got pricing pressure, mines that are progressively, by their very nature, being depleted, and shareholders looking for growth, the temptation is pretty clear. Earnings growth has to be either generated internally – by finding new mining opportunities or getting better yields from current mines – or externally, by buying the growth you need.

Now, to be fair to management, investors are a tough lot. If you don't provide the growth investors demand, they'll drop your stock like a stone and your board will be looking for answers.

If the only way to get that growth is to pay over the odds for it, then, like Tom Albanese, you'll have to pay the piper at some point. Growth at any cost can come, well, at any cost.

Of course, as investors, we can be sympathetic to management, but that sympathy doesn't extend to having to buy the shares of the company!

Stay away, at least for now

We've long counselled our members and readers against rushing into mining companies. We simply don't think they're compelling propositions when we can't forecast commodities prices (and no-one reliably can), and especially when prices are at historic highs.

We might get interested if commodities prices crash and the market becomes overly pessimistic, because that's when we'll be getting them on sale.

The other highlight (or lowlight, depending on your perspective) is the impact of poor acquisitions. In any industry, a chief executive and board who throw money at new businesses (to gain scale, diversify their businesses or "buy growth") should be viewed sceptically.

Yes, there are examples of clever and inexpensive acquisitions – we're not suggesting they're all bad – but investors should tread with extreme caution when any chief executive is seen with the chequebook out.

In many industries, executives are promoted because they're good at their previous jobs. That's understandable. One of the most overlooked skills required of a chief executive, however, is that of capital allocator. It's their job to work out how much the company should pay in dividends, how it should manage its debts and what (if any) acquisitions or divestments should be conducted.

It's a skill honed to almost-perfection by the likes of Warren Buffett, and sadly lacking in many chief executives, who are expert salespeople, operations geniuses, marketing boffins, but rarely master capital allocators.

Foolish takeaway

Investors tend to love "story stocks" – companies that have exciting presentations and are forging a brave new world. China bulls have been insatiable in their appetites for China stories – we all know about the "stronger for longer" boom. Even if they're right, that doesn't make miners in general and Rio in particular great investments.

The decades-long boom in air travel has done wonders for tourism, but the international aviation industry has lost money, in aggregate, over the past decade. Similarly, the car is ubiquitous, but the hundreds of car manufacturers have dwindled to a handful – two of which needed bailing out only a matter of years ago.

An interesting story doesn't make for a great investment. Indeed, some of the most boring companies in the world have delivered the best gains over time. Investment success is most likely to come from a simple formula free of jargon and hype: buy quality companies with bright futures at attractive prices.

(Attention: A company paying strong dividends is less likely to waste it, because you get the spare cash. Foolish, dividend-loving investors and BusinessDay readers alike can click here to request a Motley Fool free report, "Secure Your Future with Three Rock-Solid Dividend Stocks".

Scott Phillips is a Motley Fool investment analyst. You can follow Scott on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).