The Vodafone (LSE: VOD) share price currently offers one of the highest dividend yields in the FTSE 100.
At the time of writing, the stock yields 8.8%, that’s compared to the market average of 4.3%. However, I believe that it’s only a matter of time before management has to reduce this distribution to investors and, when they do, the Vodafone share price could collapse.
Watch out below
City analysts have been speculating Vodafone will have to cut its dividend for years and, so far, the company has managed to defy expectations.
Indeed, alongside its interim results in November last year, new chief executive Nick Read told shareholders Vodafone has no plan to cut its dividend in the near term, which took quite a few analysts by surprise. That’s because the company also unveiled a first-half loss of €7.8bn following asset writedowns.
Still, while the company seems to believe it can continue to maintain its current level of distribution, there’s no getting away from the fact that it has over €30bn of debt and dividends are not wholly covered by earnings per share.
With this being the case, I think it’s more likely Vodafone will cut its dividend than maintain it at current levels indefinitely. The problem is, when the company does eventually announce the cut, it will catch shareholders by surprise, and there could be a significant drop in the share price.
So, rather than take this risk, I think it is probably sensible to avoid Vodafone altogether, rather than try and second guess the business.
Many other FTSE 100 companies offer the same kind of return for less risk. Take global mining giant Rio Tinto (LSE: RIO) for example. At the time of writing, shares in this iron ore giant support a dividend yield of 5.4% and trade at a forward earnings multiple of just 10.6.
Market-leading cash returns
On top of these attractive metrics, Rio is virtually debt free. At the end of fiscal 2018, it reported net liabilities of -$625m (an overall cash position), meaning the company has paid off more than $18bn of debt since 2013.
This figure is impressive enough, but the company has also returned $24bn of cash to investors via dividends over the same time frame. If we include share repurchases, in 2017 and 2018 alone, Rio distributed $17bn to shareholders and paid off $5bn of debt.
I cannot think of any other business in the FTSE 100 that’s returning so much cash to investors. And it doesn’t look if this trend is going to end anytime soon. Rio’s company-wide efficiency drive since 2013 now means the group has more money than it knows what to do with, and shareholders are the ones benefitting the most.
The bottom line
Compared to Vodafone, with its enormous debt pile and multi-billion dollar losses, Rio looks to me to be by far the better investment, and that’s why I would sell Vodafone and buy Rio instead. The risk of owning Vodafone is just not worth taking for the extra 3.4% of yield.
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Rupert Hargreaves owns no share 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.
Motley Fool UK 2019