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Based on today’s Royal Mail (LSE: RMG) share price, I could have doubled my money if I bought the shares in September 2020. That’s a little under 18 months. I would’ve been thrilled with a 100% return in that short time period!
But I need to understand if it’s possible to double my money today. The share price has fallen from its high of over 600p (it’s only 430p as I write). Let’s take a look if I could generate a 100% return from here.
The investment case
The rise in the Royal Mail share price was kick-started back in September 2020 by the company saying: “We have seen a substantial shift in our business from letters to parcels. The strong growth in parcel volumes is being driven by B2C and e-commerce”.
Because of this, Royal Mail was generating better-than-expected revenue. Then, in the full-year results to 28 March 2021 (FY21), the company said its performance was “well above initial expectations driven by strong parcel growth”.
The pandemic certainly shifted shopping habits online, which has had a positive impact on Royal Mail’s parcel delivery services. For me, this is a key growth driver, and a reason to consider buying the shares.
Also, Royal Mail’s cash flow generation is expected to be strong in the following years. Analysts are expecting a free cash flow yield of 10%+ from FY22 through to FY24. This should translate into growing dividends, and potential share buybacks.
Issues to resolve
Things haven’t been plain sailing for Royal Mail, though. In fact, the company is undergoing a transformation at present to streamline its business. It’s going to involve significant investment as it focuses on digitalising its services, and expanding internationally through subsidiary GLS. This is an important step for the company, particularly as it has recognised the need to adapt from a traditional letters delivery service to parcels. Nevertheless, it’s a big project, and will come with significant risks if it’s not executed right.
Something else to note are the cost headwinds both Royal Mail and GLS are experiencing today. If this escalates, then profit expectations will surely decline. This will weigh on any share price gains.
Could the Royal Mail share price double?
The big question for me is: can I double my money if I buy Royal Mail shares today? This means the share price would need to reach 860p.
There are two factors that could make the share price double: explosive earnings growth, or an increasing valuation.
I don’t think earnings will explode from here. Royal Mail did get a significant boost from e-commerce sales during the pandemic. But I don’t see this repeating at quite the same rate today. Indeed, earnings growth for FY22 is expected to slow to 14% from the previous 165% in FY21.
Then, based on a price-to-earnings (P/E) ratio, Royal Mail shares are valued on a multiple of 7.5. The P/E ratio would need to double to 15 if I was going to double my money. I just don’t see this happening, either, given that the growth rate it slowing.
So, I can’t see the Royal Mail share price doubling from here. The company is going in the right direction, in my view. And there might be a growing dividend to come. But I wouldn’t buy the shares if I wanted to double my money.
Dan Appleby 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.
