Vodafone (LSE: VOD) shares fell almost 20% last year. As a result, they currently trade at a low valuation and offer a high dividend yield.
Is it worth snapping up a few shares in the telecoms giant for my portfolio? Let’s discuss.
Trading at a low valuation
Let’s start with a closer look at the valuation here. For the year ending 31 March, City analysts expect Vodafone to generate earnings per share (EPS) of 7.3 euro cents. They then expect EPS of 8.6 euro cents the following financial year.
This means that at Vodafone’s current share price of 68.6p, the forward-looking price-to-earnings (P/E) ratio here is around 10.9, falling to around 9.3 using next year’s EPS forecast.
Now, for reference, the median P/E ratio across the FTSE 100 index is about 14 right now. So Vodafone shares are trading at a discount to the market.
This could be a value opportunity. However, I can see some reasons for the discount.
For starters, Vodafone isn’t generating any growth at the moment (while lots of other companies are). This financial year, revenues are forecast to fall by about 5%.
Secondly, the company has a massive debt pile on its balance sheet. At 30 September, net debt stood at €36.2bn. This is a bit of a risk now that interest rates are much higher.
It’s worth pointing out that Vodafone has set out a plan to improve its business performance. And it appears to be making progress here. For example, debt has been reduced lately.
If it can continue to deliver on this transformation plan, I can see scope for a move higher in the valuation and the share price.
Monster dividends?
Moving on to the dividend, it’s certainly eye-catching. Last financial year, Vodafone paid out a total of nine euro cents per share to investors. At today’s share price, that translates to a trailing dividend yield of a whopping 11.3%.
The thing is, I’m not convinced it can continue to pay out such large dividends.
As I mentioned earlier, earnings this financial year are only expected to be 7.3 euro cents. In other words, they won’t cover the dividend.
Secondly, there’s the debt pile I mentioned. I think the company is likely to prioritise paying this down.
It’s worth noting that the consensus dividend forecast within the analyst community is 8.3 euro cents per share for this financial year and 7.5 euro cents per share the following year. These are still large payouts.
In reality though, we don’t know what dividends will look like. Ultimately, there’s a fair bit of uncertainty here.
Should I buy?
Vodafone shares do have the potential to deliver solid returns from here, in my view.
If the company can improve its growth and balance sheet, its share price could rise. Meanwhile, I’d expect dividends to remain attractive, even if they’re cut.
However, given the lack of growth and large debt pile, I don’t see the shares as a ‘strong buy’ today. So I’m going to focus on other investment opportunities for now.
