Neil Woodford is the 800lb gorilla in the UK fund management world. His style is quite similar to mine and the one covered in UK Value Investor, so any trades that Mr Woodford makes is of interest to me as well as thousands of keen investors.
However, some of his actions of late have left me a bit puzzled, including his sale of Tesco, which he effectively sold to Warren Buffett (and generally you don’t want to be selling what Buffett is buying).
Now that Woodford has sold his Vodafone shares it raises the same question: Is he doing the right thing, or is his outstanding track record beginning to come to an end?
Looking back in time
The first thing I like to do is cast my eyes back over the last decade, to see how well a company has created value for its shares and therefore its shareholders. The results for each of Vodafone’s shares look like this:
It’s easy to see why Vodafone is such a favourite with many fund managers and individual investors.
Over time sales, earnings and dividends have been heading in the right direction – i.e. upwards. In a little more detail, the growth rate has been around 11% a year, while the growth quality (a measure of how reliable that growth has been) is almost 90%.
The market average on the other had (measured by the FTSE 100) can only manage a 4% growth rate with growth quality at 74%.
So in that respect Vodafone is an above average business because it has grown faster and more consistently than average.
Last year was a bit of a shock though, with earnings down considerably. The question is whether this is reversible, and whether it will impact on the dividend.
Thinking about the present
I’m not a big fan of concentrating on the present. To me it seems that 90% of investors look no further than the next 12 months, and I think that’s a big mistake.
They’ll look at Vodafone and see the lower earnings per share, the revenue falls in Europe and the uncertainty over Verizon. They’ll check the news to see if this quarter’s results were better or worse than the “market’s expectations”. Ultimately, I think the vast majority of this time and effort is a waste, and adds little or nothing to investor gains in the long-term.
The point isn’t that there is uncertainty surrounding Vodafone. The point is that the future of all companies is uncertain, whether we like it or not. In fact, the absence of doubt is often a sign that things are about to go badly wrong.
You only have to look back to 1999 when everybody “knew” that dot-com stocks were the place to be, or 2006 when property was a one way ticket to riches beyond our wildest dreams.
So when I’m analysing a company, I’m quite happy for there to be some obvious uncertainty and a lack of consensus about what will happen. That’s often necessary in order to buy companies at attractive prices (think Tesco’s profit warning in 2012).
Instead, what I’m looking for is current problems that might significantly impact the company’s long-term ability to generate returns.
That generally means cyclical issues like recessions are not all that relevant, assuming the company can come out the other side. That’s a big assumption, and in turn means low and easily manageable debt levels are important so the company can survive the rough periods which are an inevitable part of business.
From my research I can see no obvious reason why the events surrounding Vodafone today should have a substantial negative impact on the company’s long-term future. Debt levels are also just three times the earnings of recent years, so I don’t think that Vodafone is going to go bust any time soon.
Having looked at the company’s successful past, and what I consider to be a reasonably benign present, I see no obvious reason to sell Vodafone shares on the basis of the quality of the company.
Gazing into the future
By “the future” I don’t mean next year, or perhaps the year after. I’m talking about five or ten years down the line; the sort of time period over which the changing intrinsic value of the business has more impact on the share price than investor sentiment.
Although my crystal ball is a little cloudy, my very rough and ready estimate is that we will still have a high-tech telecoms industry a decade from now. Although there could be some new technology which completely turns the industry on its head, it certainly isn’t obvious to me what that might be – unlike the very obvious, see-it-coming-a-mile-off demise of HMV and Blockbuster.
So again, I see no obvious reason to sell Vodafone shares based on the idea that the industry in which it operates, or the markets that it sells to, will shrink or vanish in the next few years.
Weighing up the valuation
With the share price at 172p, Vodafone is currently selling for about 12 times last year’s earnings, and also about 12 times the average earnings of the last decade, which I like to call a company’s proven “earnings power”; its ability to generate profit across one or more business cycles.
Those valuations are both lower than average, assuming the FTSE 100, with valuations at 12.1 and 13.7 respectively, represents the average of large businesses.
It’s the same story with dividend yield. The dividend yield on Vodafone’s shares is around 5.5% while the FTSE 100 has a dividend yield close to 3.5%. That’s a 57% increase in starting income for owning Vodafone shares rather than the large-cap index.
As you can probably guess, I see no obvious reason to sell Vodafone shares based on an excessive valuation, as Vodafone’s shares are currently cheaper than average as measured by PE ratios and dividend yields.
Of course there’s more to analysing a company than this, but these simple metrics can help to provide a useful guide to whether or not a company is high quality (high growth rates, high growth quality), and whether its shares are attractively priced (low PE valuation and high yield).
In this case I do still think Vodafone is an above average business with a below average price, so for me, selling today would not be the right decision.
Disclosure: I own shares in Vodafone and Vodafone is also a holding in the UK Value Investor model portfolio.
You may also be interested to know that a famous hedge fund manager, David Einhorn, also shares your love of Vodafone – here’s his thesis (taken from his 2012 Q4 letter):
“We have also increased our Vodafone (UK: VOD) holdings, as the stock fell sharply on news that just doesn’t seem that bad. After achieving an August peak of £1.92, the shares ended the year at £1.54. At this valuation, it appears that the market is placing no value on VOD’s 45% stake in Verizon Wireless. And the Verizon Wireless stake is clearly quite valuable. Look at it from Verizon’s perspective: Historically, Verizon had a very profitable landline business, and Verizon Wireless owed it billions of dollars. Verizon received Verizon Wireless’s free cash flow as it repaid the debt. For years, Verizon used its control to try to starve VOD by refusing to allow Verizon Wireless to pay dividends. Today,
Verizon’s landline business generates no cash and the debt from Verizon Wireless has been repaid.
Verizon’s 55% control stake in Verizon Wireless is probably worth more than all of Verizon’s market capitalization, and Verizon has become wholly dependent on dividends from Verizon Wireless to fund its parent company obligations and shareholder dividends. Excluding any contribution from Verizon Wireless, VOD stock pays a 7% dividend and trades at less than 12x cash earnings – roughly in line with other large European telecom companies. Meanwhile, VOD has never become dependent on Verizon Wireless distributions.
Given the huge valuation disparity between what the market thinks Verizon Wireless is worth to Verizon (at least a couple hundred billion dollars) and what it ascribes to VOD (about zero), combined with Verizon’s increasing dependence on Verizon Wireless, it wouldn’t surprise us if Verizon decided to buy all of VOD to gain full ownership of Verizon Wireless. It could decide to become a global telecom leader or it could spin out parts of VOD that it’s
not interested in owning. Maybe there is an investment banker with time on their hands reading this letter.”
John Kingham says
Hi Mark, yes I saw that analysis the other day. It’s an interesting way of looking at it. Also, I read your blog about the “Outsider CEO” book, bought it, read it, loved it, and now it’s on my shelf of books to read over and over again until it’s carved into my brain. Thanks.
Glad you enjoyed the book as much as I did! Apparently we’re in good company based on this tweet about Charlie Munger’s Daily Journal Meeting:
“Warren Buffett recommended a book to new Berkshire portfolio manager Todd Combs, called The Outsiders by William Thorndike. Munger recommended it with enthusiasm.”
“In fact, the absence of doubt is often a sign that things are about to go badly wrong.”
Exactly! I was thinking about this very issue yesterday, as it happens. I recently read how the stock market will falter due to the many unresolved economic issues facing the UK and Europe. The problem is, when there is no fear we’re probably at a market top. Compare it to the late 90’s, when Greenspan declared a Goldilocks economy. We all know what happened to the market next.
John Kingham says
Although the idea works best when the prevailing wisdom is so all encompassing that it’s heresy to speak against it. At the moment I still think the main consensus is that we’re doomed, even though the market has risen so strongly.
I think people will be astonished at the levels the market can reach in the next decade once the economy brightens a bit and we have a few years of record highs (above 7,000) in the footsie. Then we’ll realise how much the average person has avoided stocks in recent years. Eventually the man in the street will see repeated news about record stock market highs, the pain of 2000-2010 will fade, and the “great rotation” will really get going. Roll on footsie 10,000…
Retirement Investing Today says
I’m with you John. I added VOD to my HYP on the 21 December 2013 paying 155.2p a share. I have no intention of selling at this time.
John Kingham says
Hi RIT, I thought you were mostly an index tracking asset allocation kind of guy? Is your HYP just to add some spice to the whole retirement thing?
Perhaps Mr Woodford took the sim card out of his smartphone for a week, and found he didn’t need a network provider after all. I live in the Netherlands which maybe a few years ahead of the curve, but with free at the point of use wifi at home, on the train, at work, in the coffee shop – It’s amazed me for a number of years that the largest component of most people’s ‘safe’ pension is invested in a company so vulnerable to ubiquitous Internet access.
John Kingham says
Hi Rob, interesting point. I’m sure somebody somewhere must pay for that ‘free’ access. However, I think if this threat does become obvious enough (to me at least) then I would reconsider… but that may take a few more years yet. Also, I’m not sure that Vodafone is the “largest component” of most pension investments? An old work pension fund that I have is probably fairly typical in that it’s split between global bonds and global stocks, so I would guess that Vodafone is in there but far from the largest component. I think it’s over 50% in bonds for a start.
Mark Carter says
Agreed, John. Someone is paying for the internet access.
In my dreamworld of the future – which has yet to happen despite my many years of speculating upon it – I imagine that people will get charged a flat rate for all their telecomm usage. That makes sense, when you consider that there is such things as VOIP, now.
Probably wont happen, of course, but I do reserve the right to call myself an investing visionary if it happens in the next 20 years 😉
One can only assume that Neil’s found a better investment elsewhere. The price drop in Q4 would have had a lot of value investors jumping on board due to the reasons you’ve outlined. I like your idea that the absence of doubt leads to things going wrong as this is a pattern I have observed for some time.
I do agree with David.
Neil W. needed to make his move. I met him 3 mths ago together with other investment advisers and he was overconfident that the pharma sector is very, very cheap. I do agree with him to some extent and I own lots of pharma stocks. All the patent expiry dates and discounted cashflows from these are priced in by the markets, sometimes with a negative stance.
The only chance for Neil is to get it right now.
Tesco or Vodafone may be OK as stocks but they don’t have anything special to them as these are companies that operate in very competitve markets with margins under pressure. I don’t own any of these shares and I doubt the Verizon valuations above as it is hard to predict the cashflow for a telecom company and the need for future investments to keep up with competitors.
He had other reasons to sell Vodafone. The cashflow of the fund is negative so he needs to sell something and the 2012 results for Astrazeneca came poor at the end of January and he wanted to fill up when others sell this stock. Astrazeneca is his favorite stock at the moment.
John Kingham says
That’s a good point Eugen, that Woodford a) think there are better things out there like AstraZeneca (which I also rate and own) and b) has to sell because of in and outflows from his funds. That’s why I like the idea of investment trusts because there are effectively no in and outflows, other than those which the board and fund manager decide to do themselves. Personally I’d rather run an investment trust, but the problem is growing AUM, precisely because you don’t have inflows when the fund does well!
John Kingham says
David, yes it’s the old unknown unknowns thing, where we don’t really know what’s going to happen but we think we do, so we don’t know what we don’t know. But then some bad news comes along and some of the unknown unknowns become known unknowns, people realise (at least until the news turns good again) that they don’t know what will happen.
John O'Sullivan says
I recently came opon your Vodafone discussion and would like to add my tuppance worth. A 2013 whitepaper forecast by Cisco Systems of internet data growth would suggest that mobile will get its fair share of the explosive demand for bandwidth over the next 5-10 years.
Current global standard LTE chips from Qualcomm (which are in production) are multiple times faster on download and will continue the smartphone data/bandwidth demand growth hockey stick growth curve.
The recent purchase of LTE bandwith at 10% of the price paid for 3G in the U.K.bodes well for continued growth in the long run.
I look at Vodafone as one of the gatekeepers into the town called mobile communications which you have to pay to gain access.
John Kingham says
Hi John, you’ve taken a very bullish position there, so as a shareholder in Vodafone I can only hope that you’re right! My gut feeling is that you could well be.
Interesting post and comments. I think Vodafone is definitley a stock for the long run and is at an attractive price currently. Their dividend has always been a favourite with many. Anyways being a novice investor its always great to see other peoples opinions on stocks and their reasons for it.
Great site, lots of interesting investment ideas, and I can see from the spreadsheets in the free guide that like me you have experiences of Business Intelligence and KPIs!
Anyway I had a go at completing the Equity Income Worksheet for Vodafone today, and worryingly the graphs produced look very different to yours!
I grabbed my data from Investegate which is where I thought you got yours from and used the diluted EPS figures but they look way out. Way out enough that nobody would ever consider them!
Any chance I can send it over and you can advise? Or you can let me know where you got your figures from? Yours say adjusted so maybe from somewhere else.
Also can you really trust the adjusted EPS figures? Are they independantly audited?
John Kingham says
Hi Lee, yes EPS is a tricky subject.
I do prefer to use “adjusted” or “normalised” earnings, as these attempt to strip out changes to goodwill and extraordinary items. So for Vodafone in say 2006 there was a £23 billion loss due to impairment of goodwill on mobile operations in Germany, Italy and Sweden. However, that goodwill impairment didn’t impact revenues, cash generation or dividends, so in many other ways it wasn’t actually that significant to shareholder returns (ignoring share price movements). I’ve replied to your email with a few more details.
Thanks for the great in depth reply John, and it does highlight that although you can use mechanical means to “value” a company if there are any extreme figures high/low you should really be reading the commentary in Annual Reports to help make your decision before you decide to purchase/not to invest in a company.
I suppose on the flip side to the Vodafone asset write down there could well also be (an intangible) asset write up being the undervalued Verizon stake too.
With regards to your FTSE100 figures you use as a comparison, where do you find those figures? And sometimes is it prudent to filter those by industry as some are more undervalued/overvalued than others?
John Kingham says
The FTSE 100 earnings figures in the spreadsheet are just inferred from the PE in each respective year. The dividends come from the yield. I’ve collected the PE and yield data from various places over the years, as it certainly doesn’t appear to be available from one official place, which is a shame.
I haven’t re-weighted the index figures based on industry or anything else as the idea is compare individual stocks to a benchmark which is available to everybody and can be followed with a zero-effort investment policy (i.e. buy and hold a FTSE 100 tracker). If a stock can’t beat the zero-effort option (“beat” on a historic quantitative basis) then in my opinion it’s better to move on and look for something else.