Why the Vodafone share price and 7.6% dividend yield may make it the bargain of the FTSE 100

Vodafone Group plc (LON:VOD) is one of the most out-of-favour stocks in the FTSE 100 (INDEXFTSE:UKX). Now could be the perfect time to buy, says G A Chester.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The Vodafone (LSE: VOD) share price has performed poorly so far in 2018. It ended last year at 235p and has fallen a whopping 25%.

I saw good value in the stock at 184p in early July. The forecast 12-month price-to-earnings (P/E) ratio was 18.4 and the prospective dividend yield was 7.1%. The shares have subsequently declined further to around 176p. The P/E has come down to 17.4 and the dividend yield has risen to 7.6%. Is Vodafone now even better value or has news since July dampened my enthusiasm for it?

Sustainable dividend?

Vodafone’s dividend has always been a big part of the total return equation for investors. The current yield is higher than it’s been for many years and this makes Vodafone a strong investment proposition — if the dividend is sustainable.

Should you invest £1,000 in Anglo American right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Anglo American made the list?

See the 6 stocks

Some commentators are concerned that Vodafone’s earnings haven’t been covering its dividend and that it may not be able to afford the payout in the future. However, I believe this concern is overdone. When it comes to assessing dividend affordability, accounting earnings can be less useful than free cash flow (FCF). This is the amount of cash a company has left over after paying all its operating expenses and maintenance capital expenditures.

As the table below shows, while Vodafone’s accounting earnings aren’t covering its dividend, its FCF has increased to a much healthier level, both before the costs of spectrum acquisition (part maintenance and part growth capex) and after.

  2016 2017 2018
Earnings (€bn) 1.83 2.25 3.22
FCF pre-spectrum (€bn) 1.27 4.06 5.42
FCF (€bn) (2.16) 3.32 4.04
Dividends (€bn) (4.19) (3.71) (3.92)

As you can see, FCF for the financial year ended 31 March 2018 was well ahead of earnings and covered the dividend. It’s worth noting, incidentally, that while Vodafone’s P/E is relatively elevated, its P/FCF is more attractive.

The company stated in its last annual report that investment in spectrum will be higher in the next two years. Nevertheless, on a longer view it said: “We expect that our FCF generation will — on average — continue to cover our dividend obligations.” And the board reiterated its intention to increase the dividend each year.

Strong balance sheet

Vodafone’s net debt at the last year-end was €31.5bn compared with shareholders’ equity of €67.6bn, giving gearing (net debt as a percentage of shareholders’ equity) of 47%. This level of gearing is relatively conservative. BT’s is 93% and a number of popular FTSE 100 dividend stocks have gearing of well over 100%.

Vodafone’s strong balance sheet can comfortably accommodate its agreed €18bn deal to buy cable networks in Germany and eastern Europe owned by US firm Liberty Global. The acquisition, which is subject to regulatory approval, is expected to complete in mid-2019 and should be a further driver of future FCF and dividends.

Bargain buy?

Vodafone reported intense competition in India and increased competition in Italy and Spain in a Q1 trading update last month. However, challenging conditions in some markets are almost inevitable for an international behemoth. And with the board reiterating its outlook for the full-year, I didn’t see anything in the trading update to derail Vodafone’s near-term or longer-term prospects, or to suggest that the stock isn’t a bargain.

Of course, there’s no saying whether it is the bargain of the FTSE 100 — there are other contenders — but I believe the stock has the potential to deliver a high total return for investors. As such, I rate it a ‘buy’.

But there are other promising opportunities in the stock market right now. In fact, here are:

5 stocks for trying to build wealth after 50

The cost of living crisis shows no signs of slowing… the conflict in the Middle East and Ukraine shows no sign of resolution, while the global economy could be teetering on the brink of recession.

Whether you’re a newbie investor or a seasoned pro, deciding which stocks to add to your shopping list can be a daunting prospect during such unprecedented times. Yet despite the stock market’s recent gains, we think many shares still trade at a discount to their true value.

Fortunately, The Motley Fool UK analyst team have short-listed five companies that they believe STILL boast significant long-term growth prospects despite the global upheaval…

We’re sharing the names in a special FREE investing report that you can download today. We believe these stocks could be a great fit for any well-diversified portfolio with the goal of building wealth in your 50’s.

Claim your free copy now

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester 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.

More on Investing Articles

Investing Articles

Nvidia stock is down 24% this year. Time to buy the dip?

Christopher Ruane has been eyeing Nvidia stock as a potential addition to his portfolio for a while. Is a recent…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Down 25% since January, this resilient dividend stock’s catching my eye

Maintaining the UK’s rail, water, and energy infrastructure isn’t the most exciting business. But it has made this a solid…

Read more »

Investing Articles

Prediction: Unilever to outperform the FTSE 100 over the next 12 months

The FTSE 100 has made a strong start to 2025, but Stephen Wright thinks a popular dividend stock could be…

Read more »

Investing Articles

I just bought this legendary S&P 500 tech stock for my ISA, 27% off its highs

This S&P 500 stock has tanked over the last month and Edward Sheldon has snapped it up for his portfolio…

Read more »

Young black man looking at phone while on the London Overground
Investing Articles

2 beaten-down stocks to consider for an ISA after the massive market sell-off!

The stock market has had a sudden meltdown! Yet our writer thinks these two growth stocks look attractive candidates for…

Read more »

British Pennies on a Pound Note
Investing Articles

I asked ChatGPT what the best UK penny stock was. This is what it said…

Can AI find winning penny stock investments? Zaven Boyrazian puts ChatGPT to the test and discovers a potentially interesting opportunity.

Read more »

Investing Articles

These FTSE 100 stocks could be the winners from Trump’s tariffs!

President Trump’s unpopular tariffs caused mayhem on the world’s stock markets this week. But some FTSE 100 stocks bucked this…

Read more »

Investing Articles

Are these 3 sold-off UK shares secretly screaming buys?

Despite the FTSE 100 rising, there are still plenty of struggling UK shares. But are these three sold-off stocks potential…

Read more »