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The Royal Mail share price: what’s next for the stock?

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The Royal Mail (LSE: RMG) share price has surpassed my expectations over the past 12 months. Since hitting a multi-year low of around 119p in March of last year, the stock has jumped 250%. 

Pandemic growth 

It seems to me that the coronavirus pandemic has led to a significant improvement in investor sentiment towards the business. For years, Royal Mail struggled with falling letter volumes and revenues, which had impacted profitability and sales. The pandemic exacerbated the decline in letter volumes but, on the flip side, it also led to a substantial increase in parcel volumes. 

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The company rose to the challenge. The introduction of automated parcel sorting machines helped improve efficiency. Meanwhile, the introduction of a parcel pick-up service billed as “one of the biggest changes to the daily delivery since the launch of the post box in 1852,” seems to have been well received. 

Thanks to these changes, Royal Mail’s outlook has substantially improved. This time last year, analysts were expecting the company to report earnings per share of 11p for 2021. Today, that figure is 25p. 

To me, these figures show that Royal Mail has been able to take advantage of the changing shopping habits driven by the pandemic. Doing so looks to me as if the business has been able to overcome the challenges it has faced in the past. 

What’s next for the Royal Mail share price

The big question is, what happens next? It seems to me the primary reason why the stock has performed so well over the past 12 months is the fact analysts now think the company will return to growth in 2021/22. 

Unfortunately, it now looks as if much of this potential is already factored into the current share price. Indeed, shares in the organisation are currently changing hands at a forward price-to-earnings (P/E) multiple of around 16, falling to 14 for 2021.

However, in the past five years, the stock has struggled to get above a 10 times forward earnings valuation. To put it another way, it looks to me as if shares in the group are overvalued by 60% to 40% at current levels. 

That being said, Royal Mail has surpassed all expectations over the past 12 months. As such, I wouldn’t rule out further growth from the company in the near term. If the group can develop and consolidate its position in the parcel market, I reckon it’s highly likely the Royal Mail share price could continue to move higher. 

Therefore, I’m cautiously optimistic about the company’s future potential. As the e-commerce market’s size continues to grow, demand for Royal Mail’s services may also continue to increase. That could lead to further earnings upgrades. On that basis, I’d continue to own the stock in my portfolio, even after its recent positive performance. 

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Rupert Hargreaves 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.