Should You Be Tempted To Sell Regis Resources Limited (ASX:RRL) Because Of Its P/E Ratio?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Regis Resources Limited’s (ASX:RRL) P/E ratio to inform your assessment of the investment opportunity. Regis Resources has a P/E ratio of 14.16, based on the last twelve months. That corresponds to an earnings yield of approximately 7.1%.

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How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Regis Resources:

P/E of 14.16 = A$4.9 ÷ A$0.35 (Based on the trailing twelve months to June 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Regis Resources increased earnings per share by a whopping 25% last year. And earnings per share have improved by 28% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does Regis Resources’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Regis Resources has a higher P/E than the average company (10.3) in the metals and mining industry.

That means that the market expects Regis Resources will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.

Remember: P/E Ratios Don’t Consider The Balance Sheet

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Is Debt Impacting Regis Resources’s P/E?

Regis Resources has net cash of AU$181m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Regis Resources’s P/E Ratio

Regis Resources’s P/E is 14.2 which is about average (15.1) in the AU market. With a strong balance sheet combined with recent growth, the P/E implies the market is quite pessimistic.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free visual report on analyst forecasts could hold they key to an excellent investment decision.

But note: Regis Resources may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.