At over 10%, the dividend yield of Vodafone (LSE:VOD) shares is one of the highest in the FTSE 100. But with the share price falling, is it worth it for investors?
The big issue is the sustainability of the company’s dividend. If the business can keep paying its shareholders, its share price should stabilise, making the stock a bargain – but that’s a big ‘if’.
Vodafone shares
Since the start of the year, the Vodafone share price is down 10%. So if I’d invested £1,000 in the stock at the start of the year, the market value of my investment would be £102 less today.
The company has paid out 7.4p in dividends per share since January, though. So I’d have received £84 in distributions from the business.
As a result, I’d be down £18 overall on a £1,000 investment – a 1.8% loss. That’s only slightly worse than the FTSE 100, which is down 1.4% since the beginning of January.
Vodafone’s share price has been disappointing, but its dividend returns have been above average. The combination has generated similar results to the broader index.
Consistent dividend payments have been rewarding for passive income investors. The real question, though is how long these can continue.
Passive income
The reason the Vodafone share price has been falling is because investors doubt the company will be able to maintain its dividend. If they’re wrong, the stock is a bargain.
In my view, there are good reasons for being sceptical about the sustainability of the firm’s dividend. The biggest problem is that the company’s heavy capital requirements.
Capital expenditures consistently account for around 50% of the cash the business generates through its operations. That weighs heavily on the amount of earnings the firm can use to pay dividends.
As an occasional thing, this isn’t a big problem – all companies need to reinvest their earnings from time to time. But the trouble with Vodafone is that the looks set to continue indefinitely.
The reason is that the company doesn’t have a big competitive advantage over its rivals. As a result, it constantly finds it difficult to improve its economics.
Potential
The case from here is by no means hopeless. The possibility of a merger with Three UK might help Vodafone achieve the scale that would help it grow its profits and maintain its dividend.
Furthermore, the company’s new CEO has been attempting to divest businesses in order to focus on improving profitability. I think this is a good move.
In the short term, selling off underperforming units might help preserve the company’s dividends while earnings falter. This won’t work in the long term, though.
Sooner or later, the company is going to have to figure out a way to increase its profitability if it is going to maintain its dividend. And the market seems pessimistic about this.
I can see that there might be a real opportunity here, if Vodafone can turn things around. But the risk to me looks too great – I think there are better FTSE 100 stocks to buy at the moment.
