1 dividend stock I’d avoid like the plague right now

FTSE 100 giant Vodafone’s monster yield suggests its a perfect dividend stock. Our writer couldn’t disagree more.

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I see dividend stocks as a wonderful way of generating passive income.

One example I’d run a mile from, however, is connectivity and digital services megacap Vodafone (LSE: VOD).

Massive 8.7% yield!

At first glance, that may seem odd. Right now, Vodafone’s forecast dividend yield stands at a monster 8.7%. That’s one of the highest in the FTSE 100.

It also compares very favourably to what I’d get from owning a fund that merely tracks the index. At the time of writing, this comes in at 3.7%.

So, why am I so negative on the stock from an income perspective?

Low cover

Well, there are a few red flags.

Part of the reason the dividend yield is so high is that the performance of the stock has been so woeful. A consequence of a falling share price is that the yield goes up. This is why it’s dangerous to focus solely on the latter and not look beneath the bonnet.

Speaking of which, the total payout for the current financial year is only expected to be covered just over once by profit. Cover of two is generally the norm. When it falls below one, it means at least part of the dividend is being paid out of reserves.

Now, this doesn’t mean that Vodafone won’t pay out the 8.10 cents (7p) per share that analysts expect. But it’s hardly a comfortable position to be in.

Where’s the growth?

There’s another, related issue for me.

When looking around for great income stocks, I want to see evidence that a business has been actively growing dividends.

The reason for this is that dividends are tangible in a sense: you either get them or you don’t. For this reason, I regard them as a reliable gauge of how a company is really doing (in contrast to lots of bullish commentary from management). And when you get increasingly higher payouts year after year, it’s a clear sign things are going well.

Examples of reliable hikers from the FTSE 100 include safety tech leader Halma, premium spirit specialist Diageo, and defence giant BAE Systems.

To be blunt, Vodafone can’t hold a candle to these stocks. As evidence of this, its total dividend was hiked by 2% in 2018 only to be slashed by nearly 40% in 2019. Another 4% fall followed in lockdown-heavy 2020. In 2021, the payout was increased by a similar amount.

That’s worryingly inconsistent in anyone’s book. And considering the huge investment required to keep the company’s networks running, not to mention the amount of debt on its balance sheet, I can’t see this trend changing soon.

Not all bad

Of course, dividends can never be guaranteed. Some of those businesses mentioned above may stumble and be forced to make cuts.

And, yes, there are certainly some very popular stocks in the market that used to pay income and no longer do; engine-maker Rolls Royce, for instance.

At least Vodafone has been paying something to its owners over the years.

Even so, no amount of mental gymnastics changes the fact that this year’s dividend is expected to be only a smidgen more than half of that returned in 2018.

Knowing this, I just can’t see why I would prioritise investing here considering there are so many better opportunities elsewhere.

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.

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended BAE Systems, Diageo Plc, Halma Plc, and Vodafone Group Public. 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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