I always think it’s a good idea to acknowledge one’s own mistakes when it comes to investing. So, I’ll hold my hands up and say that I was wrong to be dismissive of Royal Mail (LSE: RMG) shares a couple of years ago, at least based on returns since then.
Royal Mail shares: top performer
Over the last year, the RMG share price has climbed 184% as the company has been boosted by lockdown-influenced trading. With practically all of us stuck at home, all those online orders needed to arrive somehow. No wonder the FTSE 100 member hit a purple patch.
To its credit, Royal Mail has also used the pandemic to streamline its business and cut costs where it can. This brings me to another thing I’ve come to like about RMG. It does extremely well on something called the Piotroski F-Score. This measures how financially fit a company is based on how it responds to nine criteria listed below. Those who satisfy all or most of these tend to far outperform those that score poorly.
- Is it making a profit?
- Is it generating cash?
- Is it making more cash than it’s reporting as profit?
- Is it more profitable than it was last year?
- Is its long-term debt manageable or falling?
- Is it able to pay short-term debt?
- Is it unlikely to need to tap shareholders for cash?
- Is it managing to reduce costs?
- Is it more productive than last year?
Based on data from Stockopedia, RMG gets a tick for all of the above. This gives it a maximum score of 9 on this measure. So, this means Royal Mail shares are more likely to outperform going forward, right?
Well, they certainly still look cheap. Despite the serious gains made, Royal Mail shares trade on just 8 times earnings as things stand.
On top of this, analysts expect the total cash return in this financial year (to 28 March) to be nearly double what was returned in 2020/21. A 19.8p per share return would mean a yield of 4% at today’s price. As someone who will never turn down a dividend if one is offered, that looks pretty enticing to me.
However, there can be no guarantees. Although some reduction is perhaps inevitable now that the UK has completely emerged from lockdown, it could be the case that parcel volumes fall by more than anticipated. Perhaps in anticipation of this, it’s interesting to note that Royal Mail shares have actually pulled back in recent months. Since hitting a 52-week high of 613p back in June, we’ve seen the stock fall almost 20%.
So, would I buy Royal Mail shares now?
Probably not. My main issue with RMG is that it still doesn’t hit the quality metrics that I look for. These include high returns on capital employed (or the payback a company generates from the amount of money it invests in itself). Over the long term, this has been shown to be a great predictor of investment outcomes. And as a Foolish investor, it’s the long term that I’m most concerned about.
So, while accepting that I missed out on making money from them over the last 18 months, Royal Mail shares still aren’t right for me today. I think there are still better options on my watchlist.
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Paul Summers has no position in any of the shares 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.