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Does Vodafone Group plc Pass My Triple Yield Test?

Like most private investors, I drip-feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.

However, the FTSE’s gains mean that the wider market is no longer cheap, and it’s getting harder to find shares that meet my criteria for affordability.

In this article, I’m going to run my investing eye over Vodafone Group (LSE: VOD) (NASDAQ: VOD.US).

The triple yield test

Today’s low cash saving and government bond rates mean that high-yielding shares have become some of the most attractive income-bearing investments available.

To gauge the affordability of a share for my income portfolio, I like to look at three key yield figures –the dividend, earnings and free cash flow yields. I call this my triple yield test:

Vodafone Group Value
Current share price 236p
Dividend yield 4.4%
Earnings yield 6.5%
Free cash flow yield 2.8%
FTSE 100 average dividend yield 2.9%
FTSE 100 earnings yield 5.7%
Instant access cash savings rate 1.5%
UK 10yr govt bond yield 2.9%

A share’s earnings yield is simply the inverse of its P/E ratio, and makes it easier to compare a company’s earnings with its dividend yield. An earnings yield of 10% equates to a P/E of 10, while a yield of 5% is equivalent to a P/E of 20.

Vodafone’s 6.5% earnings yield equates to a P/E of around 15, which places Vodafone slightly below the FTSE 100 average.

On the other hand, Vodafone’s 4.4% dividend yield is considerably above average, but the firm’s lower free cash flow yield of 2.8% shows that the dividend hasn’t been covered by free cash flow over the last year: Vodafone is struggling to maintain dividend growth in the face of lacklustre performance from its southern European businesses.

What next for Vodafone shareholders?

The sale of Vodafone’s 45% stake in US mobile operator Verizon Wireless is due to complete on 21 February. This could be the trigger for the next stage in Vodafone’s evolution; a rumoured takeover by US giant AT&T, which is said to covet Vodafone’s European business.

However, this may not materialise, and Vodafone’s plan otherwise is to focus on its data and enterprise offerings in Europe, and to continue to grow its businesses in Africa and the Middle East.

I remain a fan of Vodafone, but I think that its current inflated valuation could come under pressure after the Verizon Wireless sale, if a bid from AT&T doesn’t materialise. While I would be happy to cautiously add to my existing holding, I don’t think now is the best time to make a new investment in Vodafone.

A telecoms alternative

There are only two telecoms stocks in the FTSE 100 -- Vodafone and BT Group. Although BT's market cap is just 26% that of Vodafone, BT enjoys a far greater level of profitability than Vodafone and has a larger share of its home market.

These issues, and more, are explained in-depth in "The Motley Fool's Guide To Telecoms Investing". This brand-new special report provides a detailed, nine-point comparison of BT and Vodafone, and highlights some surprising differences between the two stocks.

For instant access to your free copy of this report, simply click here now.

> Roland owns shares in Vodafone Group but does not own shares in BT Group.