By anyone’s standards, 11% amounts to a high dividend yield. But that’s what Vodafone shares are currently offering.
Despite this, the share price has fallen by around 60% over the last five years. So is the high dividend worth buying into despite the declining share price?
Stock market returns
If I’d invested £1,000 in Vodafone shares five years ago, I’d have been able to buy 544 shares. Since then, the company has distributed 35p in dividends per share, meaning I’d have received £190.
At today’s prices, though, the market value of my investment would be roughly £400. Offsetting the dividends I’d have received against this would leave me down around 41% on my original investment.
There’s no way around it – that’s not a good result. And this doesn’t allow for the fact I might have reinvested my dividends along the way to increase my ownership in the company.
In doing so, I could have grown my investment to 686 shares. But with the share price continually falling, the market value of this at today’s prices would have been £505.
So from a stock market perspective, Vodafone’s declining share price has partially been countered by its dividends. But is this the right way to think about it as an investment?
Warren Buffett
One of Warren Buffett’s most important principles is that the stock market is there to serve investors, not to inform them. This is a lesson from his mentor Benjamin Graham.
The point is that whether the price of a stock goes up or down doesn’t directly tell an investor anything about the business. It only shows what other stock market participants think about it.
As Buffett points out, someone who doesn’t want to sell their shares doesn’t need to worry about what the stock price is. Instead, they ought to concentrate on what the business will produce for them.
By these standards, Vodafone could be seen as ok for investors if we factor out the initial investment. A £1,000 investment in 2018 would have returned £190 over the last five years – around 3.8% per year on average.
A 3.8% annual return isn’t terrible, especially considering where interest rates have been. But it’s a long way from the 11% on offer at today’s prices, so is there an opportunity at today’s prices?
A dividend stock to buy?
Vodafone’s share price has been falling because investors believe its dividend is going to prove unsustainable. And it’s not hard to see why.
The company operates in a capital-intensive industry. On top of this, it’s hard for any business to gain a meaningful advantage, making it difficult to earn good returns on the cash it uses in its operations.
In addition, Vodafone’s balance sheet has a lot of debt. At some point, that’s going to have to be repaid and rising interest rates will make servicing this more expensive in the near future.
The business is attempting to restructure, including a merger with Three, to try and improve efficiency. But it looks to me as though investors are right to think there’s a lot of risk here.
In my view, Vodafone’s 11% yield doesn’t make it worth buying at today’s prices. The headwinds the underlying business is facing cause me to think the market’s pessimism is justified.
