Yahoo Finance Here’s What Rio Tinto Limited’s (ASX:RIO) P/E Is Telling Us
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Rio Tinto Limited (ASX:RIO) is trading with a trailing P/E of 9.7, which is close to the industry average of 9.6. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
Check out our latest analysis for Rio Tinto
Demystifying 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. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as 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 = $54.06 ÷ $5.592 = 9.7x
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 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. Rio Tinto Limited (ASX:RIO) trades on a trailing P/E of 9.7. This isn’t too far from the industry average (which is 9.6). This multiple is a median of profitable companies of 25 Metals and Mining companies in AU including Aeris Resources, Citigold and Highlands Pacific. One could put it like this: the market is pricing RIO as if it is roughly average for its industry.
Assumptions to be aware of
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to RIO. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Rio Tinto Limited is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to RIO may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to RIO. 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. 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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
