For decades, Vodafone (LSE: VOD) shares have been a staple of income portfolios.
However, over the past couple of years, shares in the telecommunications giant have lagged the market. Indeed, over the past three years, the Vodafone share price has produced a total return of just 4.8% per annum compared to a return of 5.6% for the FTSE 100 over the same timeframe.
The company’s performance has only deteriorated over the past year. In 2021, the stock produced a total return of -1%, compared to 18.4% for the FTSE 100 index.
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So the question is, what is going wrong with the Vodafone share price? Why is the company underperforming the market so significantly despite its defensive qualities?
Challenges and headwinds
It seems as if there are a couple of reasons why the market has been giving the stock a wide berth over the past couple of years.
First of all, the company has struggled to compete in the increasingly competitive European telecommunications market. To try and overcome some of these challenges, it recently acquired the European business of Liberty Global. However, this acquisition lumped the group with an enormous amount of debt.
Management has been trying to get this borrowing under control by selling off assets and cutting costs. These initiatives are making inroads, but the market still seems concerned about the group’s obligations. With interest rates starting to increase, the cost of maintaining this debt will only increase for the business.
At the same time, the competitive headwinds that were in place before the acquisition remain.
Having said all of the above, City analysts expect the company to return to growth this year and in 2023. Analysts are projecting a net profit of €3.3bn for 2023 compared to a loss of €920m for 2020.
Profit growth should help Vodafone reduce its debt and invest in network growth. This could help improve investor sentiment towards the business, especially if this investment results in sales and earnings growth.
Vodafone share price valuation
Unfortunately, it looks to me as if there are already a lot of expectations baked into the company’s stock price.
At the time of writing, the shares are trading at a forward price-to-earnings (P/E) multiple of 15.6. That looks expensive for a telecommunications company, even though it may report strong growth over the next couple of years.
A dividend yield of 5.7% is desirable, but I am not sure this payout is sustainable. Vodafone has had to cut its distribution in the past to try and free up more cash to reduce debt. There is no guarantee the company will not have to take the same action in future.
So overall, it looks as if the market is waiting to see more progress from the corporation before awarding it a higher multiple. As such, I think the Vodafone share price will continue to languish until the business can prove its growth potential.
Nevertheless, I would still buy the stock for my portfolio today as an income and recovery play.
