Shares in Royal Mail (LSE: RMG) have been cut in half over the past seven months, falling from a high of 630p at the beginning of May to just 280p today. Following these declines, the stock now offers a dividend yield of 8.8% and trades at a price-to-book value of only 0.7 — an extremely attractive valuation for value-focused investors.
Today I’m going to consider whether shares in the company offer value or if FTSE 100 income champion Persimmon (LSE: PSN) is a better addition to your portfolio.
Shares in Royal Mail have been under pressure over the past 12 months because the company has disappointed investors repeatedly. At the beginning of the year, City analysts had been expecting the group to report earnings per share (EPS) of 42p for its 2019 financial year. Now, after a series of weak trading updates, the City is only expecting EPS of 27p, a year-on-year decline of 69%.
With the lower earnings target factored in, the shares don’t look particularly cheap in my mind. At the time of writing, they are trading at a forward earnings multiple of 11.4. And while the shares might look cheap on a price-to-book basis, if we strip out intangible assets, the stock is trading at a price-to-tangible book ratio of 1, which once again does not look particularly cheap in my opinion.
And the dividend? Well, this looks to me to be on shaky ground. It is only just covered by EPS, and with earnings falling, the outlook for the payout does not look good.
Robust balance sheet
In comparison, homebuilder Persimmon has one of the strongest balance sheets in the FTSE 100. The company’s current cash balance is around £1.2bn compared to Royal Mail’s total indebtedness of £470m.
Unlike Royal Mail, Persimmon is also highly profitable, which gives me confidence that the business will continue to produce enough profit to hit its cash return targets over the next few years. Analysts have the company returning a total of 229p per share for 2018, and 235p for 2019, giving a dividend yield of 12% for that year. The numbers suggest the distribution will only be covered 1.2 times by EPS, but I think this is acceptable considering the fortress balance sheet and management’s flexible policy of returning cash.
Indeed, rather than commit itself to a progressive dividend policy, management has decided that the best way of returning capital to investors is with a combination of special and regular dividends, which gives the group more flexibility to turn the tap off in bad times and on again when growth returns.
On top of Persimmon’s more attractive dividend credentials, the company also looks undervalued when compared to its former FTSE 100 peer Royal Mail on earnings. The shares are changing hands for just 7 times forward earnings today.
So, after considering the above, I think that when compared to Royal Mail, Persimmon is the better buy, both from an income and valuation perspective.
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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.