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Should I buy Vodafone shares for the huge dividend yield?

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Vodafone (LSE: VOD) shares have had a significant pullback recently. As a result, they now offer a very high dividend yield.

Here, I’m going to take a closer look at Vodafone’s yield and analyse whether it’s sustainable. I’ll also discuss whether I’d buy the FTSE 100 telecommunications stock for my own portfolio today.

It has an 8%+ yield

Right now, City analysts expect Vodafone to pay out €0.088 per share for FY2023 (ending 31 March 2023) and €0.09 for FY2024 (ending 31 March 2024). These are big payouts. At the current share price and GBP/EUR exchange rate, these projected dividends equate to yields of over 8%.

However, when a yield is that high, it’s often a signal a dividend cut is coming. So is that the case here? Possibly.

Dividend red flags

One thing that stands out to me is that the company has paid exactly €0.09 per share in dividends for the last four financial years. This kind of pattern – where there’s no growth in the payout – is often followed by a cut.

Another thing that stands out is dividend coverage (the ratio of earnings to dividends) is very low. At present, the earnings forecasts for FY2023/24 are €0.104 and €0.11 respectively (these will probably be downgraded shortly as the company recently provided weak full-year guidance). These forecasts give dividend coverage ratios of just 1.18 and 1.22. Generally speaking, a ratio under 1.5 indicates a high risk of a dividend cut.

Third, the company has a significant amount of debt. At 30 September, it had net debt of €45.5bn on its balance sheet. Interest payments on this debt are going to take priority over dividends to shareholders.

Putting this all together, I think there’s a chance Vodafone could cut its dividend in the near term. If it did, the stock could experience further weakness.

Would I buy the stock for income today?

When I invest in dividend stocks, there are certain things I look for:

  • Long-term growth potential
  • High level of profitability
  • Strong balance sheet
  • Long-term dividend growth track record
  • High dividend coverage

Companies that have these attributes tend to be good investments over the long run.

Looking at Vodafone, it falls short in all of these areas. In recent years, Vodafone has struggled to generate top-line growth. And looking ahead, it’s hard to see where growth is going to come from.

As for profitability, it’s very low. Last year, for example, return on capital was just 4%. Meanwhile, Vodafone’s balance sheet is quite weak, given the high level of debt it’s carrying.

It also doesn’t have a long-term dividend growth track record. Only a few years ago it cut its dividend.

Finally, as I mentioned earlier, dividend coverage is very low.

Better dividend stocks to buy?

So while Vodafone shares do offer an attractive yield right now, I won’t be buying them for my portfolio. All things considered, I think there are safer dividend stocks to buy for my portfolio today.

The post Should I buy Vodafone shares for the huge dividend yield? appeared first on The Motley Fool UK.

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Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK has recommended Vodafone. 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.