The Royal Mail share price is sinking. Is it a bargain or value trap?

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Royal Mail PLC (LSE:RMG) is a postal and delivery service company mainly focused on delivering parcels and letters. I have always viewed the stock as a simple business with potential to be a reliable income bet for my Stocks and Shares ISA portfolio. Yet, despite the Royal Mail share price halving in value since the start of 2022, I still intend to avoid buying, and I’ll explain why.

Are Royal Mail shares a value trap?

Despite the cheaper share price, my interpretation of the market’s current view of the company is not a flattering one. The company’s price-to-earnings ratio (the price per share vs earnings per share) is currently 4.3 times. This represents an sizeable valuation discount compared to the peer average of roughly 40 times. It suggests investors are only willing to buy the stock for a fractional amount above what the company earns. This is certainly not a positive endorsement considering the lofty multiples investors are paying for similar stocks.

Of course, the glaring discount for the Royal Mail share price has naturally caught my attention. Particularly for an investor like me that hunts down bargain opportunities. However, I believe that the current price-to-earnings valuation demonstrates how bearish the market feels about the stock relative to its wider sector.

Royal Mail share price hampered by bleak outlook  

City analysts are more bullish than I am. Their median price target for the Royal Mail share price over the next 12 months is a heady £377.50. This is equivalent to a 30% rise in the share price.

However, I believe these bullish forecasts will be hamstrung by the bleak earnings outlook for the Group. Earnings are forecast to decline by an average of 13.5% per year for the next three years. It is a dire outlook for the shares.

Could the stock be attractive to income investors?

I focus on selecting undervalued companies that possess robust long-term growth prospects. But I do not believe Royal Mail shares can offer me this.

But I also like to select companies offering high, regular income at a cheap price. And the company may sneak into this category.

Its dividend is due an increase in September 2022 to 13p. This will take its annual dividend payment yield from 9.8% to 15% of the stock price. It is above what most companies in the industry pay. And above the UK’s current rate of price inflation (8%). I believe this is a highly attractive feature for the shares.

Why I’m avoiding Royal Mail shares

As such, I find Royal Mail shares more attractive for income than growth, due to the dividend yield being so high. My only concern is that its dividend track record has been unstable (it changed its dividend policy as recently as 2021). And with earnings per share set to fall significantly over the next couple of years, I think the sustainability of the dividend could be in jeopardy too.

Meanwhile, I foresee the share price sinking even lower due to the bearish earnings outlook.

Despite the huge discount available currently, Royal Mail’s dividend policy looks too erratic. While its future earnings growth looks unlikely. I feel both of these variables will combine to keep a lid on any share price uplift.

Therefore, as a growth investor, I plan to avoid buying the stock for the foreseeable future.

The post The Royal Mail share price is sinking. Is it a bargain or value trap? appeared first on The Motley Fool UK.

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Henry Adefope 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.