With a 10% dividend, is this stock a passive income machine?

With a huge dividend, could investing in Vodafone be a winner for growing passive income? Gordon Best investigates.

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With the cost of living rising, making sure our money is working hard is critical. We’ve all seen in the last few years how having an emergency fund and passive income streams can be a game-changer for our financial wellbeing. So is investing in stocks with a high dividend, such as Vodafone (LSE:VOD), the way to go? Let’s take a closer look.

Crunching the numbers

With a dividend yield of 10%, I’d likely get some great passive income from an investment in Vodafone. But it’s important to remember I need the share price to perform well too. There’s little point having a 10% dividend if I’m going to lose all of that in the share price declining. However, if I like how the business looks, and have done my research, a generous £1,000 a year dividend return on a £10,000 investment could set me up nicely for the future!

How does the company look?

Most of us are familiar with Vodafone, one of the major telecommunication providers in Europe and internationally. It also provides a range of Internet of Things, AI, and analytics tools for businesses. The Vodafone share price has been on a downward trend for several years now as the European telecoms sector was abandoned by investors moving to more lucrative sectors.

During the tech boom of the 2000s, Vodafone was actually the largest listed company in Europe. It has clearly fallen a long way since. However, with economic uncertainty, and demand for essential utilities likely to grow, there could still be an opportunity here for investors looking to generate passive income.

Is the company in good shape?

I always want to have a clear understanding of how the company makes money before I get too excited about a high dividend stock. The price-to-earnings (P/E) ratio of 2.1 times is pretty interesting when compared to the sector average of 15.6 times. A discounted cash flow calculation puts fair value at £2.46, suggesting there could be a further 69% for the share price to grow. However, many analysts also suggest the pain for investors could continue.

I don’t mind a little uncertainty within a company, especially if it gives me a nice passive income. But a forecast reduction in earnings by 58% in each of the coming years is a huge red flag. This is likely skewed by one-off earnings last year, but doesn’t inspire confidence.

The major item I’d want to be confident of is the stability of the dividend. If I’m investing for passive income reasons, I don’t want to risk this being reduced suddenly. The dividend is well covered by income, with only 21% of this currently used for payments. This means there is still plenty of room for the dividend to grow if the company can find efficiencies elsewhere.

Is the passive income worth the risk?

For me, I love having dividend stocks in my portfolio, but only when the risk is minimal. At 10%, investors are being rewarded for taking a risk in Vodafone. If the company continues to struggle, I can see there being pressure on the dividend, which could send investors running for the exits. I suspect the company will turn things around over the long term, but I’ll be seeking passive income in less risky stocks.

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.

Gordon Best has no position in any of the shares mentioned. The Motley Fool UK has recommended 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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