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Is there turnaround potential in the Vodafone share price?

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·3-min read
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Vodafone (LON:VOD) shares are trading on a price to earnings (P/E) ratio of 14.0, below the company's five year average P/E of 29.0. And investors seem to have noticed the opportunity, with shares outperforming the market by 11.1% in the last year.

Investors should pay attention because finding value stocks 'on the move' is a popular and successful approach. This combination of value and momentum is a heavily researched and well documented way of finding shares. Like all value investing strategies, it can be hard to stick with, but decades of analysis shows that it has the potential to reap promising returns.

So what indicators can point to a strong blend of value and momentum, and how does Vodafone stack up against them?


The value component

The earnings yield takes a company’s profits and compares it to its current market valuation (enterprise value). Using the enterprise value takes into account cash and debt and the calculation gives us a good idea of the total value of the stock. Expressed as a percentage, an earnings yield above 5% is a good sign of value. Vodafone beats this with an earnings yield of 5.70%.

The price to sales (P/S) ratio tells us how cheap a company is relative to its current sales. The calculation is quite straightforward, taking the current share price and dividing this by its sales per share. A P/S ratio of less than 1 is said to offer good value. Vodafone is below this level, with a Price to Sales ratio of 0.93.

But beware! Value on its own is risky. If there are no other positive factors at play, there's a chance you're looking at a value trap.

The momentum driver

Momentum makes this value strategy work harder. Signs of positive price momentum can be a clue that an attractively valued stock is starting to re-rate. Indeed, momentum has been shown to be a very predictable driver of stock market profits.

To assess price momentum we can use relative strength, which compares the share price change to the underlying market index over a specified period of time.

Outperformance and strong momentum is an indicator that a share might continue its upward trend. Vodafone’s relative strength over the past year stands at 11.1%.

But momentum in stocks isn't just about price trend; it's also about momentum in earnings. Many investors want to see consistent growth and punchy earning progression in stocks, and nothing says that more than a company that beats earnings expectations.

Firms that with financial results that beat analyst forecasts can see their share prices surge, but surprisingly the prices of high performing shares can be slow to move when they publish positive earnings news. Research shows this happens because investors are cautious about bidding high performing shares any higher (even if they deserve it). Psychologists call this anchoring. As humans, we tend to take our time when it comes to changing our opinions in the face of new information - even when it's good news.

This emotional tug-of-war often ends with the ‘new high’ stock drifting higher in price over the coming weeks and months. The upward trend is called “post earnings announcement drift”. As the news sinks in, momentum takes over and the price moves higher.

In its last set of financial results, Vodafone beat earnings expectations, which could help explain some of the price momentum of the last few months, but also suggests that the company is on a strong trajectory, potentially with more upside to come.


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