Is the Royal Mail share price the bargain of the year?

Following these declines, some investors might be tempted to buy into the household name at what looks like an attractive price. However, I’m not convinced that the shares offer value at current levels and today I’m going to explain why.

Ignore the chart One of the biggest mistakes investors can make is becoming anchored to a share price. This essentially means being fixated on a stock chart without considering the company’s underlying fundamentals.

For example, shares in Royal Mail are currently changing hands for just over 250p, which is undoubtedly less than the 570p investors were willing to pay at the beginning of April 2018. On that basis, the stock looks cheap.

However, this time last year, investors were paying around 20 times earnings for the stock. Today, shares in Royal Mail are changing hands for just 9.3 times earnings. These numbers tell me that this time last year, investors were paying a relatively high price for the shares and from this perspective, the stock doesn’t look particularly cheap today compared to where it was 12 months ago.

I think that now the valuation has fallen back to earth, rather than being cheap, the Royal Mail share price is fairly valued. Just over 9 times forward earnings seems an appropriate price to pay because analysts are expecting the group’s earnings per share to fall 69% in 2019 and a further 6.4% in 2020.

Market-beating dividend The Royal Mail share price might not look particularly attractive from an earnings perspective, but it does offer a market-beating dividend yield of 9.6% at the time of writing. So, is it worth buying the shares for this income?

This question is difficult to answer. Some City analysts believe the distribution is unsustainable because it is currently consuming a lot of cash, which might be better deployed reducing debt and investing in Royal Mail’s operations.

On the other hand, some analysts think that if the company can eke out further operational efficiencies, it can sustain the distribution and invest more in the business too. Indeed, last year, the firm generated a free cash flow of approximately £570m and only distributed £231m to shareholders.

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Considering these figures, I am inclined to believe that the payout is sustainable, although I wouldn’t be surprised if management did reduce the distribution by around 50%, which would free up more than £100m per annum to reduce debt and invest in the business.

With this being the case, I do not think it is sensible to rely on Royal Mail’s 9.6% dividend yield.

The bottom line So overall, even though the Royal Mail share price has underperformed the FTSE 100 by nearly 60% over the past 12 months, I do not think that the shares are a bargain at recent levels.

Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2019