This FTSE 100 stock could earn me passive income with a 6% dividend yield

With a 6% dividend yield and 8% gain since the start of the year, I’m considering buying this FTSE 100 stock to hedge against a high inflation rate.

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Key Points

  • Vodafone has outperformed the UK index since the start of the year, and pays a healthy 6% dividend.
  • As a large cap, this stock might have stunted growth and could very well just be recovering from the effects of the pandemic.
  • Its balance sheet raises questions as to how sustainable its dividend can be in the long term.

Inflation hit a new high of 6.2% in February. Vodafone (LSE: VOD) has a 6% dividend yield and is outperforming the wider UK market index with an 8% year-to-date gain. Today, I will be assessing whether this FTSE 100 stock has a place in my portfolio.

Paying dividends

High-dividend paying companies are infamous for compensating for their underperformance with large payouts. This is often seen in industries that have high levels of uncertainty or headwinds, such as metal commodities and tobacco.

However, Vodafone has managed to buck the trend so far this year. The British telecommunications company pays one of the UK’s highest dividends. In fact, it is among the top 25% of dividend payers in the UK. The payout rounds up to approximately €0.09 or £0.07 per share.

Furthermore, the Vodafone share price has also outperformed the FTSE 100 by a rather solid 7% so far this year. The surge in its share price came after its better-than-expected Q3 results. For that reason, Vodafone does look like a promising passive income stock, at least for the short term.

Dial up growth

Nonetheless, as a long-term investor, I have a strong interest in a company’s future prospects. I always look for companies that can sustain a continued level of earnings growth, even if they don’t pay dividends.

Although revenue growth from Vodafone’s most recent quarterly trading update was positive, a 3.1% annual growth rate does not entice me. With that being said, there are also positives. Most notably, revenue growth was impressive in Egypt (18.5%) and Turkey (22%). However, these two countries together only contribute 9% of the group’s total service revenue. Also, Italy (-1.3%) and Spain (-1.6%), which each contribute 20% of total service revenue, saw declines.

While I have no doubt that Vodafone has a path to recovery in a post-pandemic world, just how much it can recover by remains a question. The company’s annual earnings have been extremely volatile, sliding in and out of profitability. Revenue has been on a decline since 2015. As such, I think Vodafone’s growth prospects are limited, and so are its future dividends.

Top up your balance

Vodafone’s dividend of 6% is not well covered by its earnings. This all brings me to raise the most worrying factor about Vodafone — its balance sheet. With an extremely high level of debt and declining cash levels, the British telecommunications company does not seem to have a bright future ahead. Moreover, with interest rates continuing to rise, Vodafone is going to find it difficult to pay off all that debt without much growth. In addition, its dividend payments have fallen over the past 10 years.

Even if I was a dividend investor, I would be skeptical of receiving a healthy level of dividend payments from Vodafone for the medium to long term. I am staying clear of this FTSE 100 stock and won’t be buying it for my portfolio anytime soon.

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.

John Choong has no position in any of the shares mentioned at the time of writing. The Motley Fool UK has recommended Vodafone. 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.

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