Down 27%, this FTSE 100 stock pays a 12.4% dividend yield!

At first glance, this FTSE 100 stock has one of the strongest dividend yields. But is this big dividend just a giant trap for investors?

| More on:
Portrait of elderly man wearing white denim shirt and glasses looking up with hand on chin. Thoughtful senior entrepreneur, studio shot against grey background.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

FTSE 100 stalwart Vodafone (LSE:VOD) has endured a challenging year. The firm’s shares are down 27% amid concerns about earnings, the business’s direction, and substantial debt.

It’s worth remembering that Vodafone was actually once the darling of the blue-chip index. It had a valuation around a quarter of a trillion pounds at the peak of the dotcom boom.

But now trading with a market-cap of £17.2bn, down 53% in the last five years, is it time to consider investing in Vodafone for its huge 12.4% dividend yield?

The business

Vodafone is a multi-national communications giant. Before the pandemic, it ranked as the world’s eighth largest communications company by market-cap. Nowadays, it remains a top-10 communications company by revenue — €45.7bn in 2023 — but not by valuation.

The firm predominantly operates services in Asia, Africa, Europe, and Oceania, employing over 100,000 people. In addition to conventional communication services, it also operates a series of smaller businesses, including M-PESA — an Africa-focused payments solution.

A fall from grace

Clearly, the business hasn’t been moving in the right direction in recent years. Debt surged and the communications market has become increasingly competitive. Vodafone, and its larger peers including BT, have been partially hamstrung by the need to continually invest and upgrade telecommunications infrastructure.

Costs have increased, the cost of servicing debt has increased, and younger competition doesn’t appear to have these issues. And amid a period of higher interest rates, Vodafone really hasn’t had much room to manoeuvre.

On the upside, net debt now stands at €36.2bn, down from €45.6bn a year ago. The board clearly has been listening to investors and their debt concerns. Over the past 18 months, this has been facilitated by the sale of the Hungarian arm for €1.7bn as well as Vantage Towers for €8.61bn and operations in Ghana for €689m.

The bottom line

Is Vodafone worth investing in? Can it turn around its poor trajectory and continue to pay its extraordinarily strong dividend?

Well, while adjusted earnings may be impacted by more business unit sales, it’s clear that the below earnings per share (EPS) forecast — this is the consensus — suggests that its current 7.68p dividend is unaffordable.

Basic EPS (p)4.366.8

In short, dividend payments will have to be brought in line with earnings. Analysts see the dividend falling to 7p in 2025, but I imagine it may have to fall further after recent downward revisions to the earnings forecast.

As such, with a dividend coverage ratio under one — the company’s basic earnings are less than stated dividend — it’s not sustainable.

From a valuation perspective (as illustrated by the price-to-earnings (P/E) ratios above), Vodafone looks slightly more expensive than its peers.

The real investment hypothesis here would have to revolve around the company’s ability to change its fortunes, in a manner similar to Rolls-Royce.

I certainly wouldn’t bet against this happening, especially as interest rates fall, but I’d need some hard evidence before putting my own money there.

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.

James Fox has positions in Rolls-Royce Plc. The Motley Fool UK has recommended Rolls-Royce 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.

More on Investing Articles

Young Asian man drinking coffee at home and looking at his phone
Investing Articles

2 recession-resistant UK stocks I’d buy and hold for a decade!

Our writer details two UK stocks she believes could still continue to perform well in a recession and not feel…

Read more »

Back view of blue NIO EP9 electric vehicle
Investing Articles

Down 31% this year! Is now the moment to buy NIO stock?

NIO stock has moved sharply downwards in the past couple of months. Christopher Ruane likes the business potential -- but…

Read more »

Smart young brown businesswoman working from home on a laptop
Investing Articles

2 dividend stocks I reckon could grow payouts for years to come!

This Fool is looking for dividend stocks and explains why these two picks could be primed to grow their payouts…

Read more »

Arrow symbol glowing amid black arrow symbols on black background.
Investing Articles

Should I buy, sell, or hold my Rolls-Royce shares at £3.50?

This Fool considers what he should do with his Rolls-Royce shares following the FTSE 100 company's excellent full-year results last…

Read more »

Couple working from home while daughter watches video on smartphone with headphones on
Investing Articles

With a spare £280, here’s how I’d start buying shares this March

Our writer reflects on what he has learnt on the stock market to explain how he would start buying shares…

Read more »

Businesswoman calculating finances in an office
Investing Articles

Are these expensive FTSE 100 stocks actually brilliant bargains?

Paul Summers takes a closer look at two FTSE 100 stocks that could recover strongly in time, despite already carrying…

Read more »

Investing Articles

What might the recent Aviva share price performance tell me as an investor?

Christopher Ruane looks at how the Aviva share price has performed over the past 12 months and considers whether he…

Read more »

Investing Articles

Down by a quarter, is the BT share price a steal?

The BT share price has more than halved in the past five years. What is holding it down -- and…

Read more »