Should you buy FTSE 100 giant Vodafone for its massive 7.5% dividend yield?

Vodafone plc (LON: VOD) currently offers a huge yield of 7.5%. Is now the time to buy the stock?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Vodafone (LSE: VOD) shares currently sport a dividend yield of a colossal 7.5%. That’s one of the highest yields in the entire FTSE 100 index. But does that make the telecommunications giant a good dividend stock? Let’s take a closer look.

Slowing growth

When analysing dividend stocks, it’s important to look past a company’s headline yield and focus on factors such as business growth and dividend coverage. You want dividends that are sustainable in the long term.

On the growth front, Vodafone appears to be struggling at present. For example, a trading update released this morning revealed that for the quarter ended 30 June, total group revenue fell 4.9% to €10.9bn due to a change in accounting standards and currency headwinds. That follows on from the 2.2% full-year revenue decline that the group reported for year ending 31 March. Declining revenue is not ideal from a dividend investing perspective, as it makes it harder to grow profits and dividends.

Dividend coverage (the ratio of earnings to dividends) also looks poor at Vodafone, meaning that the company may not be able to afford to pay its dividend in the future. Last year, the group reported adjusted earnings per share of 11.7 euro cents yet paid out dividends of 15.1 euro cents. That’s a ratio of just 0.8, which does not look sustainable. In general, analysts like to see a ratio of at least 1.5.

Turning to the stock’s valuation, I also think Vodafone shares look a little pricey at the moment. With analysts expecting earnings of 11 euro cents this year, the stock currently trades on a forward P/E of 18.3, which doesn’t offer much value, in my view. Weighing up all of these factors, I don’t think Vodafone is a top dividend stock right now, despite its high 7.5% yield. I think there are better alternatives in the FTSE 100.

Dividend growth champion 

One dividend stock that I do rate highly is insurance giant Prudential (LSE: PRU) which is the largest insurer in the FTSE 100. The stock’s yield is much lower than Vodafone’s, at 2.8%, but the dividend looks significantly more sustainable and the payout has been growing at a fast pace in recent years, which is always a good thing when you’re investing for income. 

Prudential certainly offers an attractive growth story, as the group generates 30% of its earnings from Asia. With an excellent reputation across many Asian countries, the group looks very well placed to capitalise on the strong demand for savings and insurance products that we’re likely to see in coming years from the fast-growing middle class across Asia. The insurer recently announced plans to tighten its focus on Asia by splitting itself into two companies, which makes sense strategically. 

Zooming in on PRU’s dividend, coverage looks healthy with earnings expected to cover dividends by a multiple of three this year. That means there’s a high margin of safety. It’s also worth noting that over the last five years, PRU has lifted its payout by an impressive 61% meaning the dividend has grown at a much higher rate than inflation.

Yet despite the compelling long-term growth story and the rock-solid dividend, Prudential shares look cheap at the moment, trading on a forward P/E of just 11.9. I believe that’s a very reasonable price to pay for a slice of this high-quality business.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has recommended Prudential. 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.

More on Investing Articles

Investing For Beginners

4 actionable stock market investing habits that can boost my profits

Jon Smith looks at the stock market and explains how he picks the right shares to buy, running through a…

Read more »

Investing Articles

The Standard Chartered share price leaps on FY dividend and buyback news. Time to buy?

An 8% jump for a UK-listed bank on 2023 results? That's what just happened to the Standard Chartered share price.…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Can Lloyds shares get any cheaper?

Lloyds shares have fallen further following the release of the bank's 2023 results. This Fool senses now is a time…

Read more »

Aerial shot showing an aircraft shadow flying over an idyllic beach
Investing Articles

£7,000 of money to spare? Here’s how I’d aim to turn that into £1,000 in annual extra income

Christopher Ruane explains how he would aim to generate a four figure income to cushion his future, all with dividend…

Read more »

British union jack flag and Parliament house at city of Westminster in the background
Investing Articles

Is this stellar dividend growth stock the only no-brainer buy on the entire FTSE 100?

Picking shares requires careful thought and analysis, but this FTSE 100 growth stock appears to be pressing all the right…

Read more »

Investing Articles

I bought 422 Glencore shares in July and 232 in September. Here’s what they’re worth now

Glencore shares have had a rough ride leaving Harvey Jones out of pocket. Should he cut his losses or average…

Read more »

Man smiling and working on laptop
Investing Articles

Here’s why I’m investing most of my savings in FTSE 100 shares!

I think investing in FTSE 100 shares is one of the best ways that UK investors can make long-term returns.…

Read more »

Newspaper and direction sign with investment options
Investing Articles

When cheap markets meet favourable conditions, sentiment flips very quickly

London’s stock market is cheap — some sectors, even cheaper. Given a change in sentiment, the uprating could be substantial.

Read more »