Is Vodafone A Value Trap?

Published in Company Comment on 17 December 2012

A controversial view of the mobile phone company Vodafone (LSE: VOD).

Okay, I know this is going to be controversial but, as a Vodafone (LSE: VOD) (NASDAQ: VOD.US) shareholder myself, I am just sharing some of my worries and concerns about the company.

I bought shares in the business about two years ago, in the expectation of a decent progression in the share price, accompanied by some juicy dividend payments. The company was frequently touted as an excellent buy.

A disappointing investment

In this context, my investment has been a disappointment. The recent knock that the share price has taken, after a substantial earnings miss, has got me concerned. But what does this mean for the business's share price?

Over the two years I have been invested in the company, the shares have been trading in a narrow range between 160p and 190p. It has not once broken out of this range during this time.

The recent share price movement has pushed the share to the lower end of this range but, crucially, it has not broken below it.

An investing 'comfort zone'

'Trading within a range' is the investing equivalent of the 'comfort zone'. There seems to be a general consensus that the share price has reached a decent level. If it falls below that level, people start buying. If it pushes above that level, people start selling. So the share price will bounce around between these limits.

For me, Vodafone's recent earnings disappointment has not been enough for it to break below this range. This suggests to me that, eventually, the share price will recover.

Premium industry, or humdrum utility?

But can the shares break through the upper end of this range? This is debatable. The mobile phone market is getting increasingly mature. The trend is for margins to get steadily squeezed as the mobile phone industry gradually transforms from a premium, 'fashionable' industry to a humdrum utility. Often, such a transition leads to a de-rating of the shares.

What's more, much of Vodafone's business is in Europe, which continues to face some major headwinds, plus the next generation of phone licences will be a big additional expense.

The company is currently on a dividend yield of 6, and a price-to-earnings ratio of 11. That's not overly expensive, but neither is it very cheap.

However, on the positive side, the boom in smartphones means that data is increasingly important as a revenue stream, and there is still potential for growth in emerging markets.

Foolish bottom line

So my conclusion is nuanced. Vodafone is not a value trap. But I see both negative and positive points with this firm, and my worry is that the negatives will put a brake on growth, and on the share price. Earnings per share, both in recent years and forecast for the next few years, are static. Where is the driver for share price growth?

In my view, the company should be seen as a reliable income generator, rather than a business that grows rapidly into the future. I would say it might be worth a punt at current prices but, personally, I can see better value elsewhere. Agree or disagree? Please share your views in the box below.

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> Prabhat owns shares in Vodafone. The Motley Fool has recommended shares in Vodafone.

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Comments

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johnnygibber 17 Dec 2012 , 9:56am

As long as divi's keep growing SP can stay where it is and I'll be happy - my little calculation for folks having a few yrs to invest:

1. Share price will not move from £1.60 for next 20 yrs (unbelievable IMO) - 4G, etc etc
2. That dividend would grow by a measley 3% a year - currently at 7%
3. We would re invest divi's every year until I retire - 20yrs and counting.
4. I will buy £10000 of Vod today at £1.60 - and invest no more.....just leave it.(6250 shares)

So year twenty my capital will have gone from £10000 to £46500 - now have nearly 30K shares.

My income will have grown to around £5k from £630 today.

Over 50% income from my original £10K - not too shabby.

Cheers
JG

BigJC1 17 Dec 2012 , 9:58am

It's not a bad thing to have a range of "Steady Eddie" shares in the portfolio yielding strong dividends on a regular basis with a slow long term growth in value.

Are mobile phones a mature market in India, Africa, China, etc; will Southern Europe ever spend money again; will 4G/LTE offer a viable alternative to landline/cable internet; will the US growth power Verizon even stronger ?


zho 17 Dec 2012 , 10:21am

Hi Johnny,

Are you sure about your arithmetic? If dividends grow by 3% p.a. I reckon that they increase by about 81% after 20 years of compound growth. So if your current dividend income is £630 from £10K's worth of shares it will be about £1,138 in 20 years' time.

F958B 17 Dec 2012 , 10:48am

zho

If the yield is frittered on women and beer (rather than invested in more shares), then yes, the annual payout will be £1138.

But if that 7% yield is used to buy more shares, that's 7% more shares and each share is increasing its dividend by 3% per year.

Reinvested dividends go a long way towards matching capital growth of more glamorous shares which don't pay a dividend. The return from dividends is also much more predictable than share price movements.

A share growing at 3% and yielding 7% is roughly as good as a share growing at 7% and yielding 3%.

johnnygibber 17 Dec 2012 , 12:11pm

Hi zho

F958B (Ferrari ? - nor sure about the B right enough !!) - has responded perfectly. Some raw data - hopefully formatting is OK.

VOD no shares divi value income
Year 1 6250 10.20 10000 637.50
Year 2 6648 10.51 10637.5 698.48
Year 3 7085 10.82 11335.98484 766.68
Year 4 7564 11.15 12102.66442 843.09
Year 5 8091 11.48 12945.75232 928.87
Year 6 8672 11.82 13874.62541 1025.39
Year 7 9313 12.18 14900.01187 1134.20
Year 8 10021 12.54 16034.2132 1257.15
Year 9 10807 12.92 17291.36701 1396.39
Year 10 11680 13.31 18687.75889 1554.43
Year 11 12651 13.71 20242.19342 1734.24
Year 12 13735 14.12 21976.43664 1939.31
Year 13 14947 14.54 23915.7453 2173.76
Year 14 16306 14.98 26089.50136 2442.47
Year 15 17832 15.43 28531.97502 2751.27
Year 16 19552 15.89 31283.24475 3107.07
Year 17 21494 16.37 34390.30984 3518.13
Year 18 23693 16.86 37908.43976 3994.38
Year 19 26189 17.36 41902.81554 4547.72
Year 20 29032 17.89 46450.53262 5192.52

Cheers
JG

johnnygibber 17 Dec 2012 , 12:16pm

PS. Think I may have overdone the value part to 5 decimal places.....:-)

Aye aye - I need xcel for dummies.

Hopefully you get the gist.
I'll be trying this for Greggs next due to their impeccable divi record.

JG

joblot123 17 Dec 2012 , 12:24pm

nice article. VOD share is now trading at £1.56 so is this a time to buy now they are at a year low or should we all wait and see how they have done over the Christmas trading period ? comments welcome.

SimonTempler1 17 Dec 2012 , 1:23pm

vjoblot123 - 
In October - the number of mobile phone contracts that were expired/cancelled in Spain reached a new record. Vodafone lost 280,000 and Movistar 284,000 ..with Orange hardly losing any.there was a large increase in people prefering to use prepaid cards and use the phone far less or just for SMS messages. 
This is likely to be a similar story in Greece,Portugal,Italy, and those figures have been repeated month after month over the past 6 months at least - a shocking loss of revenue and customer base.
The idea that everyone is going to jump on the smartphone bandwagon is I think just wishfull thinking and I also cannot see any reason why the share price will rise much above 1.60 for the time being.

goodlifer 17 Dec 2012 , 1:49pm

I tend to get confused between Series and Sequence, but here's my thinking.

zho is talking about Sequence.
If the divvy increases by 7% a year it will have increased by about 80% after 30 years, as you correctly point out.
This is true whether you reinvest them or spend them on horse races, on wine and women or on fattening beef cattle - traditionally the quickest, the pleasantest and the surest ways for a farmer to lose money.

Series is what you get if you add up - ie reinvest - all the dividends.
If so, at 7%, I make it your capital will have grown to about 33 times it's original size.

If the divvy grows as well, your capital will obviously grow even more,
but I don't know to calculate this precisely.

Anybody know better?

zho 17 Dec 2012 , 2:45pm

Hi Johnny,

Thanks for your figures. I think you are assuming that no tax is paid on dividends - presumably the case if you hold in a SIPP - but otherwise an impressive testament to the power of compounding when dividends are reinvested.

manofmann2 17 Dec 2012 , 5:20pm

I bought into Vodafone in 2008

Since then, including reinvested dividends, the return has been over 60% (approx 13%/year) The dividends since 2008 represent 20% of my holding now.

I would judge Vodafone to have been my best investment choice, even with the recent drop in value

goodlifer 17 Dec 2012 , 10:59pm


Correction!!!!

I said, " If the the divvy increases by 7% a year it will have increased by about 80% after 30 years, as you correctly point out."

Should've said,"If the divvy increases by 3% a year it will have increased by about 80% after 30 years, as you correctly point out."

Sorry, folks.

goodlifer 17 Dec 2012 , 11:08pm

zho
"I think you are assuming that no tax is paid on dividends - presumably the case if you hold in a SIPP.

It's also the case for anyone holding an ISA, or for anyone not fortunate enough to be a higher rate taxpayer.

And - perhaps even more important - these figures make no allowance for inflation.

ANuvver 18 Dec 2012 , 3:47am

Well, my 3.5778946p opinion (compounded over x years, oh never mind)...

I think telecoms have long since become a utility, and should be treated as such by investors.

SimonTempler1:
Couldn't read your full comment - I'm interested, so can you repost.
Were you suggesting that increasingly value-conscious customers are going back to "Are you at home? Call me on the landline"? Or "You hang up... No, you hang up... no - This is her dad here, and I'm ****ing hanging up for you both, because this is costing a fortune"?

dubre 18 Dec 2012 , 10:35am

Yes,I paid 359p back in 2000.Dare say I thought it was good value then.

SevenPillars 18 Dec 2012 , 10:44am

One look at the Vodafone monthly and weekly charts will show you that there is a horrible downtrend in place that doesn't look pretty. Until sentiment changes and is reflected in the charts, i.e. the trend starts going up, no one can be certain where the bottom is for this one. Even worse for those who took the plunge and bought in the last few weeks has been the fact that at a time of reasonable strength in the FTSE, Vodafone has performed like a dog.

Vodafone is in one of those relentless, almost irrational market moves where for now it is no good in applying logic of what fair value is. Even if you like catching falling knives and have 20-30 years to spare as a long term buy and holder, it still makes sense to wait until the market decides the price has gone down enough.

If nothing else it makes sense to wait because for those of you who want the dividend why buy now if it is likely to get cheaper? You'll be able to get more dividend return, i.e. get more shares for your money if it goes lower as it looks like doing. The only thing that will show you this is a chart and even that is not an exact science as it is almost impossible to pick a bottom, but at least a chart shows the general trend for good or bad.

I'm afraid this one could easily go much lower based on what the longer term charts are showing (for anyone interested I will probably post the Vodafone weekly and monthly charts on my blog at sevenpillarstrading.blogspot.co.uk sometime today).

breelander 18 Dec 2012 , 11:04am

ANuvver SimonTempler1:
Couldn't read your full comment...


Strange, the text wrap doesn't work. However, it's all there if you copy and paste. SimonTempler1 said:

"In October - the number of mobile phone contracts that were expired/cancelled in Spain reached a new record. Vodafone lost 280,000 and Movistar 284,000 ..with Orange hardly losing any.there was a large increase in people prefering to use prepaid cards and use the phone far less or just for SMS messages.

This is likely to be a similar story in Greece,Portugal,Italy, and those figures have been repeated month after month over the past 6 months at least - a shocking loss of revenue and customer base.

The idea that everyone is going to jump on the smartphone bandwagon is I think just wishfull thinking and I also cannot see any reason why the share price will rise much above 1.60 for the time being."

ProfessorMarcus 18 Dec 2012 , 11:25am

Will the share buybacks from the Verizon payout have much effect on the share price of VOD?

goodlifer 19 Dec 2012 , 11:40pm

dubre

"I paid 359p back in 2000.Dare say I thought it was good value then."

Yes, but why?

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