Royal Mail (LSE: RMG) shares had a smashing 2021. The stock has returned 54% over the past 12 months, buoyed by rising profits. Compared to a return of just 15% for the FTSE All-Share Index over the same period. Both of these figures include dividends paid to investors.
The question is, was this performance just a one-off, or will the stock continue to beat the market in 2022?
The outlook for Royal Mail shares
Of course, it is impossible to predict how a stock will perform over the next 12 months with a high level of accuracy. But I can estimate a stock’s potential by looking at growth estimates.
In theory, a share price should match the underlying fundamental performance of the business. Therefore, if profits continue to grow next year, Royal Mail shares should follow suit. There is no guarantee this will occur.
Looking out over the next year, City analysts expect the group to report earnings growth of around 8% for 2022. That is not particularly exciting. However, the company’s valuation does leave a lot of room for expansion.
The shares are currently selling at a forward price-to-earnings (P/E) multiple of 8. The market average is around 14. So it does look to me as if there is room for the group’s valuation to expand in the year ahead. Analysts have also pencilled in a dividend yield of 4.7%.
The company’s growth and dividend figures suggest the stock could produce a return of around 10% next year. That is assuming the valuation remains the same. Returns could be significantly higher if the valuation increases to around the market average.
Still, this does not guarantee the company will outperform the rest of the market. These figures only suggest Royal Mail shares will produce a positive return next year.
Growth headwinds
The company could face multiple challenges next year, which will hold back growth. These include wage inflation and increased competition from smaller peers, who can pick and choose their markets. This could rob the enterprise of valuable income in some of its most profitable areas.
The corporation has been trying to overcome these challenges by investing more in technology. The strategy seems to be yielding results, although additional capital spending will have an impact on profit growth. The greater the competition, the more the business will have to spend to stay ahead, and the bigger the impact this will have on its bottom line.
These are the challenges I will be keeping in mind for the year ahead. Nevertheless, despite the above headwinds, I think the outlook for Royal Mail shares in 2022 is encouraging. And I think its valuation does not give the company enough credit for its potential.
As such, I would be happy to add the stock to my portfolio today as an undervalued income and growth investment.
