2 reasons the Royal Mail share price could take off

This Fool thinks the Royal Mail share price is undervalued and supported by strong fundamentals so plans to buy some for his portfolio.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Key points

  • With a P/E ratio around 7, this stock could be a great bargain
  • The underlying fundamentals indicate controlled expansion
  • Earnings growth has been strong for the past five years

Royal Mail Group (LSE: RMG) is one of the most recognisable companies in the UK. Its brands include Royal Mail and Parcelforce Worldwide. With many people ordering more online during the pandemic, the company has been performing rather well recently. There are two reasons why I think the Royal Mail share price is worth a close look for the future too and why this company could be a shrewd investment for my portfolio.

The Royal Mail share price is a ‘bargain’

I think that using a company’s price-to-earnings (P/E) ratio is a usually good way to gauge if a stock is over- or undervalued. This is found by dividing the Royal Mail share price by its earnings per share (EPS). 

Royal Mail currently has a P/E of 7.05. That’s a figure generally seen as low but on its own, doesn’t really tell me all that much. However, the average P/E ratio for the industrial transportation sector is 36.8. Furthermore, one of the company’s global rivals, FedEx, has a P/E ratio of 13.4. This suggests that the Royal Mail share price could be undervalued. I believe I could be getting a bargain at current levels.

The underlying fundamentals are strong   

Royal Mail Group has also produced solid earnings for its shareholders over the past five years. For the years to the end of March, EPS has grown from 44.1 in 2017 to 52.1 in 2021. Looking at its compounded annual growth rate, EPS has risen 3.4% each time. This is both strong and consistent. 

A recent trading update from the firm for the three months to 31 December 2021 provided some welcome news. Domestic parcels revenue grew 44% compared to the same period in 2019. That said, when compared with the same period in 2020, revenue fell 5%. This is perhaps unsurprising given that people were no longer dependent on ordering online. But it’s also an indication that the recovery from the pandemic hasn’t been great for Royal Mail’s business.

On another front, recent pandemic developments have also been negative. With about 15,000 staff absences from the Omicron variant in early January, the company’s service capability was negatively impacted. For me, however, this is a short-term issue that should subside in the very near future. The leadership team is also spending £70m in an attempt to “streamline operational management”. This will reduce the management workforce by 700 and save around £40m per year.

I see The Royal Mail share price as underpinned by strong and consistent earnings growth and think it’s a bargain when compared with its sector and competitors. Yes, there are some issues, but I think these can be resolved. I will therefore be buying Royal Mail shares for long-term growth. 

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Andrew Woods 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.

More on Investing Articles

Newspaper and direction sign with investment options
Investing Articles

When cheap markets meet favourable conditions, sentiment flips very quickly

London’s stock market is cheap — some sectors, even cheaper. Given a change in sentiment, the uprating could be substantial.

Read more »

Investing Articles

Empty Stocks and Shares ISA? I’d snap up these 3 stocks to start with!

Sumayya Mansoor explains how she would start to build wealth from scratch with an empty Stocks and Shares ISA and…

Read more »

Concept of two young professional men looking at a screen in a technological data centre
Investing Articles

7.7% yield and going cheap! Why is this unknown FTSE 250 stock flying?

It's no household name, but there's one FTSE 250 stock with a high dividend yield and booming profits that looks…

Read more »

Photo of a man going through financial problems
Investing Articles

I’d stop staring at the Nvidia share price and buy this FTSE 100 stock instead

This writer reckons there is a smarter way to invest in Nvidia today without taking on stock-specific risk. Here is…

Read more »

Young lady working from home office during coronavirus pandemic.
Top Stocks

5 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Young Asian man drinking coffee at home and looking at his phone
Dividend Shares

These 3 FTSE 250 stocks offer me the highest dividend yields, but should I buy?

Jon Smith considers FTSE 250 shares with a very high yield, but questions whether the income is going to be…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Is FTSE 100 takeover target DS Smith a great buy?

A mega-merger between FTSE 100 giants DS Smith and Mondi has the City abuzz. But is there any value in…

Read more »

Young Black man sat in front of laptop while wearing headphones
Investing Articles

The WPP share price dips as profits fall. Here’s why it could be a top dividend buy

I'm starting to think the WPP share price undervalues the stock, especially if the long-term dividend outlook comes good.

Read more »