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The Russian Public Joint-Stock Commercial Roads Bank (Public joint-stock company) (MISX:RDRB) is currently trading at a trailing P/E of 6.5x, which is higher than the industry average of 6.2x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for Russian Commercial Roads Bank
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 RDRB
Price-Earnings Ratio = Price per share ÷ Earnings per share
RDRB Price-Earnings Ratio = RUB158.5 ÷ RUB24.444 = 6.5x
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 RDRB, 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 6.5x, RDRB’s P/E is higher than its industry peers (6.2x). This implies that investors are overvaluing each dollar of RDRB’s earnings. Therefore, according to this analysis, RDRB is an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that RDRB should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to RDRB. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with RDRB, 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 RDRB to are fairly valued by the market. If this is violated, RDRB’s P/E may be lower than its peers as they are actually overvalued by investors.
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 RDRB. 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 urge you to complete your research by taking a look at the following: