Vodafone just cut its dividend by 40%. Here’s how you could have seen that coming

Vodafone Group plc (LON: VOD) just took the drastic measure of slashing its dividend. Was that a surprise though?

| 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.

Yesterday, Vodafone (LSE: VOD) announced a substantial dividend cut, which is bad news for income investors. Reporting full-year results for the year ending 31 March, the group stated that it was ‘rebasing’ its dividend from 15.07 euro cents in FY2018 to just nine euro cents for the year just passed, in an effort to tackle debt and help pay for auctions for mobile phone airwaves in Germany and Italy.

Does this dividend cut come as a surprise? Not really, in my opinion. Here were four warnings signs that Vodafone’s dividend looked unsustainable.

Sky-high yield

For starters, the dividend yield has looked dangerously high recently, which is a classic red flag when it comes to dividend sustainability. On Friday’s closing share price of 139p, last year’s dividend payout of 15.07 euro cents equated to a trailing yield of around 9.4% – over twice the average yield of the FTSE 100.

When it comes to dividend yields, the phrase if it looks too good to be true it probably is happens to be highly appropriate. That’s because a high yield is often a signal that the market is expecting a dividend cut and what has happened is that many investors have already sold out of the stock, pushing its yield up. So, when a yield is abnormally high, you have to be careful. 

Low dividend coverage

Secondly, dividend coverage was worryingly low. The dividend coverage ratio is the ratio of earnings to dividends. Generally speaking, for a dividend to be considered safe, you want to see a ratio of two or more. A ratio under one is a real problem because it indicates that the company is paying out more than it is earning.

In Vodafone’s case, adjusted earnings per share were 11.59 euro cents last year, which gives a dividend coverage ratio of 0.77. That suggests the dividend was unsustainable. The free cash flow-to-dividends ratio was low too, at around 0.99, which was another warning sign.

Zero dividend growth

Next, dividend growth had slowed. Last year, growth was only 2%, which is a low increase. Then, in its most recent half-year results, the group held its interim dividend steady. Zero dividend growth is often a precursor to a dividend cut. 

A mountain of debt

Finally, moving on to the balance sheet, Vodafone also had a big pile of debt that was rather concerning. Last year, the group had total liabilities of €78bn on its books, whereas total equity was only around €67.6bn. That gives a debt-to-equity ratio of 1.15, which is far higher than the ratio of 0.5 that Warren Buffett likes to see.

Additionally, the group took on more debt in the last year, including an $11.5bn fixed and floating rate bond. Ultimately, the large debt pile looks to be the straw that broke the camel’s back as the group has said that the reason the dividend has been cut is to help the company reduce debt and delever to the low end of its target range in the next few years.

So, looking at all these red flags, Vodafone’s dividend cut should not come as a surprise. There were certainly warnings signs. The takeaway here is that when investing for dividends, it’s important to always do a little bit of research into the sustainability of the payout.

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.

Edward Sheldon has no position in any 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

Up 8% today, is this FTSE 100 growth stock a slam-dunk buy for me?

Halma's share price is soaring thanks to another headline-grabbing trading update. Is the FTSE 100 stock now too good for…

Read more »

Investing Articles

With a P/E ratio of just 10.5 is now a brilliant time to buy a cut-price FTSE 250 tracker?

Harvey Jones says a recent dip in the FTSE 250 leaves the index trading at bargain levels. One stock in…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

To build a passive income flow, I’d follow this Warren Buffett approach

Warren Buffett has set up passive income streams most people can only dream about. Our writer sees some practical lessons…

Read more »

Growth Shares

As the boohoo share price falls, could it become a penny stock in 2025?

Jon Smith outlines some of the recent problems involving the boohoo share price and considers if things could get even…

Read more »

Young Asian woman with head in hands at her desk
Investing Articles

Here are the worst-performing FTSE 100 shares over the last 5 years

These five FTSE 100 shares have been complete duds over the last half decade. But is there potential for a…

Read more »

Investing Articles

Nvidia stock has tripled this year! Can it keep rising?

Nvidia's latest sales update showed strong growth and the stock's been on a tear so far in 2024. So is…

Read more »

Investing Articles

The JD Sports Fashion share price has just plunged another 16%! Buy or sell?

Harvey Jones is reeling after another sharp drop in the JD Sports Fashion share price. Should he seize the chance…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

This once-great FTSE 250 UK fashion retailer is down 47%, so is it time for me to buy?

A formerly iconic UK fashion brand, this FTSE 250 firm has fallen out of favour. But it has a new…

Read more »