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Should I double down on the Royal Mail share price?

After staging a small recovery at the beginning of September, the Royal Mail (LSE: RMG) share price has fallen back under 200p during the past few weeks. Following this decline, the stock is close to its all-time low of around 188p reached in mid-August. And from a value perspective, its fundamentals look highly attractive.

Indeed, at the time of writing, the stock offers a dividend yield of 8.7%, trades at a forward P/E ratio of less than 8, and a price to book value of 0.45. The big question is, should investors take advantage of this opportunity and double down on the Royal Mail share price? Or might it be best to stay away ahead of further declines? Today, I’m going to try and answer these questions.

Cheap as chips?

In my opinion, any stock trading below its book value is worth a closer look. This implies the business is currently selling for less in the market than its breakup value. Royal Mail fits the bill here. At the end of March, the firm reported total assets of £7.4bn and liabilities of £2.8bn, giving a book value of £4.6bn, or 460p per share. 

That might indicate Royal Mail is severely undervalued at current levels, although it doesn’t give us the whole picture. It’s difficult to tell if the assets Royal Mail has on its balance sheet are worth as much as the company says they are. For example, will the firm be able to collect 100% of the money owed from debtors? And would the value of its property increase or decrease if it was used for a different purpose?

Because there are so many moving parts in a book value figure, it’s always best to take this measure with a pinch of salt. Instead, analysts tend to look to a company’s earnings and productivity to determine how much it’s worth.

Falling earnings

Looking at Royal Mail from an earnings point of view, it’s clear the company has problems. Earnings per share are projected to fall 49% in fiscal 2020, after a decline of 45% for fiscal 2019. Meanwhile, return on capital employed — a measure of profitability for every £1 invested in the business — was just 3.9% in 2019. 

Generally, the higher a company’s return on capital, the higher the valuation the market will place on the business. In this case, Royal Mail’s return on capital is in the bottom 50% of the market. To put it another way, the business is one of the most productive public companies trading on the London market right now.

The bottom line

Considering the above, I reckon the Royal Mail share price deserves its low valuation. The company’s falling earnings, coupled with its low level of productivity, suggests the business doesn’t deserve a premium valuation.

Until management can improve the company’s outlook, I think the stock is going to remain depressed. On that basis, it’s probably best to stay away from the stock ahead of further declines.

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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.