Yahoo Finance Is Rio Tinto Limited’s (ASX:RIO) PE Ratio A Signal To Buy For Investors?
Rio Tinto Limited (ASX:RIO) is currently trading at a trailing P/E of 12.8x, which is lower than the industry average of 14x. While this makes RIO 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Rio Tinto
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 RIO
Price-Earnings Ratio = Price per share ÷ Earnings per share
RIO Price-Earnings Ratio = $62.83 ÷ $4.904 = 12.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to RIO, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since RIO’s P/E of 12.8x is lower than its industry peers (14x), it means that investors are paying less than they should for each dollar of RIO’s earnings. Therefore, according to this analysis, RIO is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy RIO immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to RIO, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with RIO, 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 RIO to are fairly valued by the market. If this does not hold, there is a possibility that RIO’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of RIO to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 RIO’s future growth? Take a look at our free research report of analyst consensus for RIO’s outlook.
Past Track Record: Has RIO 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 RIO’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.
