Is Vodafone a Value Trap?


LONDON -- OK, I know this is going to be controversial but, as a Vodafone 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 160 pence and 190 pence. 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 licenses 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 company, 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 Sakya owns shares of Vodafone. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Vodafone Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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