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Vodafone shares offer a 6.5% yield: should I buy them for a passive income?

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Building a portfolio to provide a reliable passive income isn’t easy. In a world of low interest rates, I want high dividend yields. But I also need to feel confident that the payouts on offer won’t be cut. I reckon Vodafone Group (LSE: VOD) shares could be an ideal choice for my income portfolio.

Here, I’ll look at the latest numbers from the group and explain why I’m very tempted by Vodafone’s share price and 6.5% dividend yield.

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Keep it simple

There are lots of complicated ways to pick shares to buy. But when I’m hunting for stocks for my passive income portfolio, I focus my efforts on one simple but essential metric. Free cash flow.

The method I use is to focus on companies which produce enough free cash flow (surplus cash) each year to comfortably cover their dividend payments. As well as looking at recent performance, I look at past years — I want a consistent record of cash-backed dividends.

Although there are companies that can pay dividends not covered by free cash flow, my experience suggests this will eventually become a problem. Dividends are paid in real cash. If the cash doesn’t come from a company’s operations, then it must come from debt or other external funding. In my experience, this usually becomes unsustainable eventually, leading to a cut.

Do Vodafone shares tick my boxes?

Vodafone boss Nick Read knows that most investors view the firm’s shares as an income investment. Free cash flow is always one of the first financial metrics that’s listed in the company’s results.

Last year, the group generated free cash flow of €4,949m, enough to cover the €2,415m dividend payout twice over. In last week’s half-year results, Vodafone confirmed that a similar performance is expected this year.

City analysts expect the €0.09 per share dividend to remain unchanged this year. This gives the stock a forward yield of about 6.5% at current prices. I see this as a safe payout. But are the shares cheap enough to buy?

Making good progress

Vodafone has been in transition over the last few years, consolidating after several large acquisitions and asset sales. However, in my view, the group is now well along this path and is making good progress.

Last week’s half-year results showed an increase in profits and free cash flow for the period. The next big improvement should come early next year when the company’s radio mast business, Vantage Towers, is due to be floated on the stock market.

Back in September, Vodafone shares were a little cheaper and offered a yield of 7.2%. At the time, I said I thought the dividend would be safe this year and that I’d be happy to own the stock for income.

Vodafone’s share price has risen a little since then. This has pushed the dividend yield on this FTSE 100 stock down to about 6.5%. My view hasn’t changed though. I still think the shares offer good value and would be happy to buy the stock for my passive income portfolio.

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Roland Head 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.