Should You Be Tempted To Sell RM Secured Direct Lending plc (LON:RMDL) At Its Current PE Ratio?

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 better understand how you can grow your money by investing in RM Secured Direct Lending plc (LON:RMDL).

RM Secured Direct Lending plc (LON:RMDL) trades with a trailing P/E of 25x, which is higher than the industry average of 16x. While this makes RMDL appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View out our latest analysis for RM Secured Direct Lending

Breaking down the Price-Earnings 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.

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. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as RMDL, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.

Since RMDL's P/E of 25x is higher than its industry peers (16x), it means that investors are paying more than they should for each dollar of RMDL's earnings. This multiple is a median of profitable companies of 25 Capital Markets companies in GB including Trading Emissions, Sherborne Investors (Guernsey) B and Argo Group. Therefore, according to this analysis, RMDL is an over-priced stock.

Assumptions to watch out for

Before you jump to the conclusion that RMDL should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to RMDL. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing riskier firms with RMDL, then RMDL’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with RMDL. In this case, RMDL’s P/E would be higher since investors would also reward RMDL’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing RMDL to are fairly valued by the market. If this assumption is violated, RMDL's P/E may be higher than its peers because its peers are actually undervalued 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 rebalance your portfolio and reduce your holdings in RMDL. 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 urge you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for RMDL’s future growth? Take a look at our free research report of analyst consensus for RMDL’s outlook.
2. Financial Health: Is RMDL’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.
3. 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.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.