Is Resource Capital Gold Corp’s (CVE:RCG) PE Ratio A Signal To Buy For Investors?
This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Resource Capital Gold Corp (CVE:RCG) trades with a trailing P/E of 1.8x, which is lower than the industry average of 9.1x. While this makes RCG 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.
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Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 RCG
Price-Earnings Ratio = Price per share ÷ Earnings per share
RCG Price-Earnings Ratio = CA$0.025 ÷ CA$0.0138 = 1.8x
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 RCG, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 1.8, RCG’s P/E is lower than its industry peers (9.1). This implies that investors are undervaluing each dollar of RCG’s earnings. This multiple is a median of profitable companies of 24 Metals and Mining companies in CA including Winston Resources, European Electric Metals and Sherritt International. One could put it like this: the market is pricing RCG as if it is a weaker company than the average company in its industry.
A few caveats
However, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to RCG, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with RCG, 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 RCG to are fairly valued by the market. If this is violated, RCG’s P/E may be lower than its peers as they are actually overvalued by investors.
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 RCG 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:
Financial Health: Are RCG’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
Past Track Record: Has RCG 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 RCG’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.
