Should I buy the highest-yielding dividend shares on the FTSE 100?

This Fool plans to generate passive income by buying dividend shares. Is buying the highest payers on the FTSE 100 a smart move?

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Image source: Vodafone Group plc

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Many investors today are keen to make some passive income. It’s certainly a goal of mine. To achieve this, I’m buying dividend shares.

There are plenty of ways to make some extra money outside my main source of income. For example, I could start a business. Or I could start to buy property.

Those methods do appeal to me. However, I find buying dividend shares more simple. If I snap them up today and hold them for the long haul, I’ll hopefully make some juicy capital gains on top of the passive income I receive.

That may seem too good to be true. But it’s not. What’s even better, I think a host of companies paying meaty yields are undervalued right now. I plan to take action.

Where to search

The majority of dividend shares I own live on the FTSE 100. It’s no secret the UK’s leading index is home to some of the best companies out there. With strong cash flows, it comes as no surprise that many are eager to return value to shareholders.

The average yield of the FTSE 100 is around 3.9%. That beats the 2% I’d receive on average from the S&P 500. It also slightly tops the FTSE 250‘s 3.4%.

Doing my homework

But while the yields are attractive on the FTSE 100, I must do my homework. Take Vodafone (LSE: VOD) as an example. It may seem easy for me to just buy one of the highest-yielding shares on the Footsie and wait for the cash to come rolling in. But would that be a smart move?

The stock’s performance in recent times has been abysmal. In the last 12 months, Vodafone shares have lost 33.7% of their value. In the last five years, they’ve fallen 52.5%.

But is there a way back? Right now, Vodafone yields 11.5%. That’s impressive. In fact, it’s the highest on the FTSE 100.

However, there are questions about its sustainability. And the poor performance of the firm in recent times has thrown the future of its dividend payments into question. For example, it doesn’t have the strongest balance sheet. As of 30 September 2023, its net debt was €36.2bn. That’s a monumental amount. Hiked interest rates won’t make it any easier to pay off.

It also generates a poor return on capital employed (ROCE). This is a measure of how efficiently a business uses its resources. Last year, Vodafone’s was 5.1%. That’s very low.

As such, the group has major restructuring plans in the pipeline. It looks increasingly likely that it’ll exit Spain and Italy, two of its core markets. Doing so should gain it €15bn. That will alleviate some of the pressure the business is facing right now.

While its price has plummeted, it does now look incredibly cheap, trading on just two times earnings.

Should I buy?

Now, I’m not saying Vodafone’s dividend isn’t safe. The future of it is unknown. But it’s a prime example of how doing due diligence can help investors begin to make more informed decisions. I’ll be avoiding Vodafone for now. I see other dividend shares out there that I feel more confident buying.

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.

Charlie Keough 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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