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Why Vodafone Group plc Jumped 11% In May

Shares in mobile phone giant Vodafone (LSE: VOD) (NASDAQ: VOD.US) climbed by 10.8% in May, to end the month at 255p — though the price has slipped back a little so far in June, to 242p as I write. In fact, Vodafone shares have been doing very nicely since late last year — from the middle of October to today we’ve seen a 31% rise, and that’s in addition to a 5% dividend yield for the year to March 2015:

Chart: The Motley Fool UK

Chart: The Motley Fool UK

But though that’s a better-than-average dividend yield, it’s nowhere near covered by earnings, and Vodafone’s forward P/E of over 40 might cause you to raise your eyebrows a little.

So what?

The price of Vodafone has long been driven by rumours or mergers and takovers — in fact, since Vodafone sold off its share of Verizon Wireless back in February 2014, its share price has rarely had any logical connection with the company’s actual earnings and dividend performance.

And that’s exactly what’s driving the current share price spike, with Vodafone finally admitting on 5 June that it “is in the early stages of discussions with Liberty Global regarding a possible exchange of selected assets between the two companies“. Speculation had been rife in the press, and the rumours had had investors reaching for the Buy button for a couple of weeks prior to the fessing-up.

What such a deal would be like is not clear, but that hasn’t stopped analysts from guessing that the best outcome might be a swap of Vodafone’s UK and Dutch mobile businesses for Liberty’s German operations.

Now what?

There’s going to be some major structural change to Vodafone some time, of that much I’m convinced. Ever since the Verizon sale, Vodafone has looked like a rag bag of unconnected businesses and I really haven’t seen much in the way of overall focus. Living on the profits from voice services in developing countries while 4G data services are ramped up in Europe has been a reasonable stopgap, but there’s little point in being a giant multinational company if you’re no more than the sum of your parts.

The big questions are whether a merger (or whetever) will generate the cost savings that should come when disparate operations achieve better synergy, and will such savings be enough to justify the current high rating of Vodafone shares?

For me the answer at this stage is a big fat No. If you buy now you’re buying on the takeover rumour, and hoping that any deal will value Vodafone shares more highly than the market does today. If that’s your strategy then I wish you well, but I’d only buy shares based on the fundamental value of a company’s actual underlying performance.

On that score, Vodafone’s profit expectations just don’t justify the shares’ lofty rating to me.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.