If there’s one thing I’ve learned from Warren Buffett, it’s never buy a stock I don’t understand. And while I have a pretty good understanding of the telecoms business from earlier in my career, I’ve spent most of the past few years totally puzzled by the Vodafone (LSE: VOD) share price.
Vodafone’s business appears to be to developing next-generation wireless data networks across developed countries in its sphere, while happily taking in cash from plain old voice services in other countries as that’s still where the biggest profits lie.
I like that strategy. But in recent years, I’ve seen high share price valuations suggesting there’s a lot more than the sum of the parts here — but I just couldn’t see what that was.
In fact, in the four years up to the end of 2017, Vodafone shares were trading at P/E multiples of around 30 to 40, and I could only see one of three things happening.
Some master plan would be unveiled that justified Vodafone’s valuation of around two and a half times the FTSE 100’s long-term average, there would be a takeover attempt (probably from an American giant), or there would be a share price correction.
That last option is what’s happened. Since December 2017, we’ve seen the Vodafone share price tumbling by 40%.
Forecasts indicate a 17% fall in EPS for the year to March 2019, but predictions of 20% rises in the next two years would drop the forward P/E to only 12, which seems far more rational.
I still don’t understand Vodafone’s massive dividends, yielding more than 9%, but not covered by earnings. But I am starting to warm to the share price, even though I still see it as a bit risky. Right now, it’s still “wait and see” for me.
There’s another, much smaller telecoms provider whose business I’ve liked for a good few years, and that’s Telecom Plus (LSE: TEP).
I had a brief shock this morning when I saw shares in a company called Utilitywise crash by 65%, only to quickly realised it’s a micro-cap company and nothing to do with the Utility Warehouse brand under which Telecom Plus operates.
But it does help highlight that smaller utilities companies are under the cosh these days, and it makes me look askance at the current Telecom Plus valuation.
Telecom Plus shares dipped from a very high valuation in 2015 and remained at something that looked more sustainable. That was until September last year when the price started climbing again.
Over the past six months, we’ve seen a 37% rise, putting the shares now on a forward P/E of 24 — and that’s with nice-but-not-spectacular EPS rises of 7-9% on the cards over the next three years.
Telecom Plus, thanks to the high earnings visibility it enjoys from its multi-utilities packages, pays out the bulk of its earnings as dividends. But although those are nicely progressive, the share price climb has dropped, predicted yields to between 3.7% and 4.2%.
That’s good income, I don’t disagree, but is it enough to justify such a high P/E valuation?
I have my doubts, and I don’t see the need to take such a risk. Not when you can pick up 6% yields from National Grid shares rated at a P/E of only 14, or 9% from Centrica on a multiple of under 12.
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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.