Here's why the Royal Mail share price is cheap

Royal Mail's (LON:RMG) share price currently languishes at all-time lows of 252p, pricing the entire company at £2.5bn and giving its shares a substantial 9.31% forecast dividend yield. It's fair to assume that its shares are cheap on a few metrics - and our StockRanks would agree with this assumption:

Stacks of academic research covering different time frames and regions of the world all conclude that, over time and on average, cheap stocks outperform expensive stocks.

But it's not quite that simple. The fact is cheap shares are often cheap for a reason. They can look unappetising. Sticking with a value strategy is actually extraordinarily hard. Sometimes the share price languishes, bad news keeps coming, and even the best investors can begin to doubt themselves.

That's why by constructed the Value Rank, which is designed to cut through the noise and offer a composite measure of the following simple valuation ratios:

• Price to Book Value
• Price to Earnings
• Price to Free Cash Flow
• Dividend Yield %
• Price to Sales
• Earnings Yield %

The Value Rank: how does Royal Mail stack up?

We can see by using Royal Mail’s StockReport that the group has a:

• Rolling price to book value of 0.59,
• Rolling price to earnings ratio of 9.30
• Trailing twelve-month price to free cash flow of 7.44
• Rolling dividend yield of 9.57%
• Trailing twelve-month price to sales ratio of 0.24

When we add all of these together, we find that Royal Mail has a Value Rank of 95. Investing in high-value stocks requires finesse and a sturdy constitution but, when cheap stocks come good, the payoff can be large and sudden.

Royal Mail’s Value Rank of 95 puts it in the cheapest quartile of the stock market. That is certainly a promising jumping off point for our analysis but it is not the whole story.

A smarter way to invest in value stocks is to find the best quality value stocks or value stocks whose share prices are turning around - history shows that you can do much better than a passive investor by combining factors, so it makes sense to consider Royal Mail’s Value Rank alongside its Momentum and Quality Ranks.

What does this mean for potential investors?

Some of the best quality stocks in the market have defensible models that can deliver high levels of shareholder returns over the long term. But there are no guarantees and it's important to do your own research. Indeed, we've identified some areas of concern with International Distributions Services that you can find out about here.