This FTSE 250 stock is down 8% today… should you buy it?

No doubt many of you are familiar with this FTSE 250 stock – we probably interact with this company on a daily basis.

Royal Mail (LSE: RMG) is a company that deliver to our doors, with postage and delivery services. It floated on the stock market back in 2013, and immediately surged to a high of 600p. In early 2018, the company ran into difficulty with a profit warning, and since then has shed its value. The price currently sits below 180p.

In the company’s latest trading update to the market this morning, Royal Mail announced that the group’s adjusted operating profit is expected to be £300m–£340m, before any IFRS 16 adjustments. 

Revenue grew 3.7%, so the company is still growing its topline figure. This is important because if a company can’t grow its topline then eventually it will struggle to grow its profits. Costs can only be cut to a certain extent – once the fat has been trimmed, cuts are into the bone of the business. 

Royal Mail trades at 11 times earnings

With a price-to-earnings ratio of 11, the stock trades at an inexpensive valuation. There are no frothy expectations built into this stock, which means that we are unlikely to see any of the huge volatility that often torments shareholders in growth businesses. However, with the business around 70% from its high, downside volatility is still a possibility. Nobody knows where the bottom is.

At 8%, the yield is in danger of entering double digits if the stock price falls further. When a dividend yield is above 10%, this usually indicates that the market does not feel that the dividend is sustainable and is likely to be cut.

Remember, income investors like solid yields that are backed by strong cash flows. If confidence in the stock is so low that the dividend yield enters double digits, that’s a sign that income investors do not have much faith in the business to continue the dividend. 

Why I wouldn’t buy Royal Mail

I don’t think Royal Mail is a bad business. I just don’t think it’s one that I would buy, as there are far better listed businesses available. Private investors don’t need to own hundreds of shares, and so we can diversify our portfolio easily by holding 20 or so solid stocks. We’re still able to concentrate our capital into our best ideas, but we have the benefit of being protected by a portfolio. 

The business faces challenges with its union and increasing competition. That would be enough for me to leave this share alone if I were an income investor. The yield is certainly something to be cautious about.

There are just far better stocks out there.