BT (LSE: BT.A) shares look interesting from an income investing perspective right now. At present, they offer a dividend yield of around 5%.
Is it worth buying a few shares in the FTSE 100 telecoms giant given the above-average yield here? Let’s discuss.
Potential for share price gains and income?
Looking at BT shares today, I can see both positives and negatives.
On the positive side, the stock has a low valuation at present. With analysts expecting the group to generate earnings per share of 18.4p for the year ending 31 March 2024, the forward-looking price-to-earnings (P/E) ratio is just 8.5.
That’s well below the UK market average. Currently, the median P/E ratio across the FTSE 100 index is about 13.9. So the stock certainly looks interesting from a value investing perspective. At the current valuation, there is scope for a re-rating higher at some point.
It’s worth noting that a number of brokers have price targets for BT that are well above the current share price. JP Morgan, for example, has a target of 275p. This is encouraging.
Another positive is that the company’s dividend looks sustainable in the near term. Currently, BT has a projected dividend coverage ratio (this is calculated by dividing earnings per share by dividends per share) of around 2.5 for 2023, which is very healthy.
So at first glance, the stock looks like it could potentially be capable of providing both capital gains and income in the medium term.
Negatives to consider
On the negative side however, BT has a massive pile of debt on its balance sheet today.
At the end of 2022, net debt stood at £19.2bn. This is not ideal, particularly now that interest rates are much higher than they were in the recent past.
Investing in companies that have a large amount of debt can backfire. That’s because the interest payments required to service the debt can put pressure on earnings and dividends.
The lack of growth here is another negative worth highlighting. Right now, BT it’s not generating any top-line growth at all. For the year ended 31 March, analysts expect revenue to decline year on year. Growth is a key driver of investment returns in the long run.
A third negative is the company’s profitability track record. It’s not great. Over the last five years, return on capital has only averaged 7.8%.
Return on capital is another key driver of investment returns in the long run. Companies that have high ratios are generally able to reinvest a lot of capital for future growth and compound their earnings.
The low return on capital here probably explains why the BT share price has gone backwards over the last 20 years.
Better stocks to buy
Putting this all together, my view is that there are better stocks to buy today.
There does appear to be potential for solid returns in the near term here.
However, for long-term investors like myself, I think there are better opportunities out there.
