Paying too much for a company is never a good idea. 10 years ago Vodafone was a cool tech company that was going to grow to the moon and was worth, at least to investors of the time, about 60 times its adjusted earnings which gave an earnings yield of 1.7%. Ouch, is all I can say.
Behind the whacky share price is a real business which operates year in year out, doing its thing to the best of management’s ability.
For example, since 2002 Vodafone has doubled revenue, almost doubled operating profit, tripled adjusted earnings per share and increased the dividend six-fold. Compound growth of adjusted earnings and revenue has been about 10% while returns on equity hovers around 9%. I estimate return on the last 10 years retained earnings at around 15%.
And the share price? After falling below 150 pence in 2001 it’s been more or less stuck there ever since.
Back in the real world Vodafone continued as a market leader in an ever growing market and became the owner of the world’s fifth most valuable brand.
Somebody much smarter than I once said “If the business does well, the stock eventually follows”, it’s just that in Vodafone’s case that ‘eventually’ has taken 10 long years. But with the current earnings yield over 10% and the dividend yield over 5% it’s highly likely that future growth will cause the share price to follow since a dividend yield of 5, 6 or 7% on a company like Vodafone is going to suck in investors like a black hole (not the most positive metaphor, I know).
The question then is can Vodafone be expected to keep growing over the next few years through whatever outrageous fortune the future may throw at it?
I think that is can. The market for mobile telecommunications is still growing, mostly in emerging markets. In mature markets growth is likely to come from data revenue rather than voice as people switch to smart devices like smartphones and iPads. I see no reason why Vodafone cannot grow as the market grows.
As for outrageous fortune, telecommunications is a defensive industry and generally isn’t too heavily impacted by economic downturns. In the same vein Vodafone is a global company which may protect it from issues in any one country. If things get ugly (should that be more ugly?) in the next few years it should provide a relatively safe harbour for any cash I invest.
Other levers to increase the share price are the progressive dividend policy and the £7 billion of cash allocated to share buybacks.
In the wise words of Warren Buffett:
Your goal as an investor should be simply to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher, five, ten, and twenty years from now
Vodafone may just fit that bill.
As at today I would consider buying more shares under 185 pence (disclosure – I already have), whereas if the price shot up due to some good news then I would consider selling at anything over 250 pence.
Mark Carter says
A timely article for me, UVI, because I have been thinking about comms quite a bit recently.
I own a bit of VOD (Vodafone) from back in January, and the price is down about 8% since then. VOD is in a lot of funds that I admire. It is top 10 holding of Artemis UK Growth, Artemis UK Special Situations, Fidelity Special Situations, and Invesco Perpetual Income. I don't think investors will go far wrong by buying VOD at current prices.
By a coincidence, VOD was highlighted over at Citywire: http://bit.ly/kckI6P . The author says that the shares are cheap, but thinks the returns on equity are too low. He goes on to say that he thinks the management have a clear plan to improve profitability, and a good balance sheet to give them flexibility. Ultimately, he isn't satisfied with this, and would rather stand back. The article is well-praised, with most commentators seeing it as a great value share; but with one author saying it is too poor a performer, and too large.
One company that I got really excited about recently was CW. (Cable & Wireless Worldwide). It is trading on en EV/EBITDA of 3.5, it's a spinoff (a positive, in my view), and forecast EPS growth is 30% for 2012, and another 10% for 2013. Very exciting on paper, but I don't think I'll be investing (unless someone can come up with a very convincing argument). There have been recent boardroom bustups – a red flag in my view. The board on Interactive Investor is bullish, but there is a bear who said the share is "dead in the water". De-ramper, maybe, but he's managed to call it right on the shares for a long time. This has given me big pause for thought, and basically scotched my enthusiasm.
I think your Buffett quote is very apt, and it's something that I need to keep reminding myself: focus on quality first, price second. Maybe if the stock market were to tank, THEN I'd buy a selection of deeper value stocks.
I know as value players we're supposed to scoff at technical analysis, but over a one year period, CW. has dropped 40%, whilst the Footsie has gained 10%. That should be telling us something.
John (UKVI) says
ROE is a bit low, but I think it might continue its trend upwards as RORE (return on retained earnings, not sure if I've just invented that acronym) might be around 15% which is more like it. I'd disagree with the 'poor performance' comment, but I suppose it depends on what time scale they're talking about. The multi-year performance looks pretty good to me.
I can't really comment on CW as it's a spin off and has no history to hand. I'm only interested in long term rock solid borderline boring companies at the moment to even out the YELLs of this world.
"In mature markets growth is likely to come from data revenue rather than voice as people switch to smart devices like smartphones and iPads."
I'm also wondering what effect (if any) concepts like smart metering (also SatNav "Live" services et al) will have on the revenues of companies like Vodaphone. 10 years from today I feel a large number (if not most) of homes will have their gas and electricity smart metered by EDF, British Gas etc.
With limited new infrastructure in conjunction with ageing existing infrastructue these companies will IMO start looking to balance/maximise total generation/distribution via concepts like this.
How are they going to get the data from these meters back to "base"? Down a broadband connection or via GPRS seem to be the 2 sensible options. Vodaphone is a player in one of those.
Hi RIT, good point. I think data is going to be a story for an expanding range of items in the future. I heard something (a bit daft) about things like contact lenses connected to the internet so that they can generate a heads up display of info about where you are etc.
Who knows? But going forward I think the interconnectedness of products in the world is only going to go up exponentially.
10 Value 10 says
Thanks for the article UKVI.
I've held Voda since early 2008 and have enjoyed a nice fat, increasing dividend, which has generated an IRR of c15%.
My concerns are the slightly low ROE (I'd like 15%) and the prospect of an auction to flog off the bandwith (4G?) for next generation telephony/data. Prices shouldn't be as crazy as previous auctions, but I'd be tempted to offload for a couple of years if there is talk of large amounts of capex.
In the meantime, I've been topping up in the past few weeks. Lots of cash to spend on buy-backs should help EPS even in sluggish markets.
Hi 10V10. ROE is a bit of a problem. I don't think Vodafone is going to grow by a huge amount by putting retained earnings into expansion, which is why the share buybacks make sense since they're buying their existing assets at below book! Nice. Although I might disagree with myself there and say I'd rather they just give the money to me in dividends.
As for 4G, I hope it doesn't go as mad as before, but who knows, I try to keep crystal ball gazing to a minimum.
Good luck and let me know when you get out. Personally I've settled in for a 5 year stretch, unless the share price goes crazy.
John Kingham says
Mark Bennett of Invesco Perpetual (manages over £1B) also likes Vodafone: