Vodafone (LSE: VOD) shares are popular among UK income investors as they offer a high dividend yield. Currently, the FTSE 100 stock sports a trailing yield of 4.9% which is certainly attractive when you consider the best rate you can get on a savings account is around 1.5%.
However, as experienced investors know, there’s more to dividend investing than just yield. When investing for income, it’s also important to look at factors such as dividend coverage in order to determine whether the payout is sustainable, as well as dividend growth to determine whether the payout will grow over time and provide protection against inflation. With that in mind, let’s take a closer look at Vodafone shares to see how the dividend stacks up.
Dividend coverage (the ratio of earnings to dividends) at Vodafone certainly looks a little worrying, in my view. Last year, the group paid out a dividend of €0.09, yet adjusted earnings per share were only €0.053 cents. This gives a dividend coverage ratio of a low 0.59.
A ratio under one is risky because it suggests the company isn’t generating enough earnings to pay its dividend. In other words, the dividend isn’t sustainable. Looking ahead, analysts currently forecast earnings of €0.086 cents and a dividend payout of €0.096 this year, which also gives a dividend coverage ratio under one.
Dividend growth at Vodafone also concerns me. As a dividend investor, you ideally want to see a consistent track record of growth here. A stock like Diageo is a great example. It has now registered 21 consecutive dividend increases.
In Vodafone’s case, however, the company actually cut its dividend last year. This isn’t what you want as an income investor as your income’s reduced.
In my opinion, a company that has recently slashed its dividend has minimal appeal from a dividend-investing perspective. There could be further cuts on the horizon.
I’ll also point out that there are a number of near-term threats to Vodafone’s dividend. Firstly, the company has a significant chunk of debt on its balance sheet. At the end of March, net debt stood at €27bn. Debt repayments always take priority over dividend payments, so this is something to be aware of.
Secondly, I expect the company to spend a substantial amount of cash on 5G network rollout in the years ahead. This capital expenditure could also threaten the dividend payout.
Finally, let’s take a look at the valuation. Currently, Vodafone’s forward-looking P/E ratio is 21.1. That looks quite high, in my opinion, given that the group just slashed its dividend by 40%. So I wouldn’t be surprised to see the Vodafone share price fall further.
Good dividend stock?
All things considered, I don’t see much appeal in Vodafone from a dividend-investing perspective. If you’re looking for income, I think there are much better dividend stocks to buy right now.
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Edward Sheldon owns shares in Diageo. The Motley Fool UK has recommended Diageo. 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.