Why I’m not following director buying at Lloyds Banking Group and Vodafone Group plc

Since the dramatic fall in share prices since the Brexit Referendum, 21 directors at Lloyds (LSE: LLOY) have shown confidence in their company by buying shares worth over £750,000. Despite the bullishness from company executives, I see enough warning flags to indicate that the banking giant won’t prove a great investment in the coming years.

The first problem is the stubbornly high costs that have plagued all major banks since the Financial Crisis. While Lloyds is in better shape than competitors its cost-to-income ratio in 2015 was still 49.3%, little better than the 49.8% posted in 2013.

With little progress being made in tackling operating costs, the bank needs to increase revenue to improve profits. Unfortunately, that’s going to be difficult for Lloyds considering its already massive size. In 2015 is originated around 20% of all mortgages in the UK and has considerable market share in small business lending and retail banking. While this reflects well on Lloyds, it also means that it realistically has little chance of growing market share enough to significantly move the top line.

Of course, higher interest rates could help boost profits but the Bank of England is likely closer to cutting than raising benchmark rates due to the threat of Brexit. Speaking of which, given the reach Lloyds has across the entire UK economy, Lloyds would be one of the biggest losers from the expected economic slowdown over the coming quarters and years.

While rising dividends have attracted many investors to Lloyds in the past months, it’s also worth noting that analysts are forecasting a double-digit decline in earnings per share over each of the next two years, which could imperil shareholder payouts. With little prospect for growth, continued billion pound payouts for PPI claims, falling earnings, and macroeconomic headwinds looming like the Sword of Damocles, even director’s purchases aren’t enough to make me consider Lloyds for my portfolio.

European struggles

Evidently directors of Vodafone (LSE: VOD) see a bright outlook for the telecoms giant as five of them have bought a grand total of £1.4m of shares over the past month. These directors may have been influenced by the 2.2% year-on-year rise in organic service revenue the mobile operator posted in Q1.

The bad news is that growth from emerging markets such as India can’t hide Vodafone’s struggles in its core European markets where organic service revenue growth was a miserly 0.3%. While positive growth is always welcome, Vodafone has spent more than £19bn improving its European 4G and broadband infrastructure in the past few years and will need higher growth rates to justify this investment and its current lofty valuation.

Shares are currently trading at 35 times forward earnings, showing that investors have already priced-in considerable growth. Equally worrying for me is Vodafone’s dividend, which was 11.45p per share last year despite earnings per share of only 5.04p. Investing in its networks as well as paying out more in dividends than it earns in profits means that net debt ballooned to €36bn at the end of Q1, a full 4.7 times EBITDA. Debt of this level is manageable for a telecoms giant with stable revenue, but slower than expected growth in core markets, uncovered dividends and a sky-high valuation are more than enough to turn me off buying Vodafone shares right now.

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Ian Pierce 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.