When Should You Buy Resolute Mining Limited (ASX:RSG)?
Resolute Mining Limited (ASX:RSG) trades with a trailing P/E of 5.7x, which is lower than the industry average of 13.1x. While this makes RSG appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for RSG
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for RSG
Price-Earnings Ratio = Price per share ÷ Earnings per share
RSG Price-Earnings Ratio = 1.08 ÷ 0.19 = 5.7x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as RSG, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since RSG's P/E of 5.7x is lower than its industry peers (13.1x), it means that investors are paying less than they should for each dollar of RSG's earnings. As such, our analysis shows that RSG represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy RSG immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to RSG, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with RSG, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing RSG to are fairly valued by the market. If this does not hold, there is a possibility that RSG’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to RSG. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If you are considering investing in RSG, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Resolute Mining for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
