Should You Buy REVA Medical Inc (ASX:RVA) At This PE Ratio?
REVA Medical Inc (ASX:RVA) is currently trading at a trailing P/E of 2.9x, which is lower than the industry average of 42.5x. While RVA might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for REVA Medical
Breaking down 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 RVA
Price-Earnings Ratio = Price per share ÷ Earnings per share
RVA Price-Earnings Ratio = $0.2 ÷ $0.07 = 2.9x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to RVA, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. RVA’s P/E of 2.9x is lower than its industry peers (42.5x), which implies that each dollar of RVA’s earnings is being undervalued by investors. As such, our analysis shows that RVA represents an under-priced stock.
A few caveats
Before you jump to the conclusion that RVA is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to RVA, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with RVA, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing RVA to are fairly valued by the market. If this is violated, RVA’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on RVA, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for RVA’s future growth? Take a look at our free research report of analyst consensus for RVA’s outlook.
Past Track Record: Has RVA been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of RVA’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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.
