Does the 9.3% yield and growing dividend make Legal & General share passive income?
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Legal & General The company (LSE:LGEN) pays a dividend of 9.3%. That is higher than FTSE 100 average, above inflation, and much better than the interest earned on cash.
That makes it look like income investors should pile into the stock. If only it were that simple – the truth is (unfortunately) it’s a lot more complicated.
A five-year comeback
Over the past five years, Legal & General has traded with a dividend yield of 6.6%. Things were different back then, but this was still an eye-catching return.
Since then, the company has increased its distribution to shareholders each year. The average annual increase has been only about 3%, but it has been remarkably consistent.
Legal & General Dividends per share 2020-24
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The problem is, this has not translated into a positive outcome for shareholders. Although it paid a total of 94.37p per share, this was largely offset by the stock falling by 82.44p at the time.
As a result, investors who bought stocks in December 2020 totaled 3.9% of their investments. That’s lower than the FTSE 100, well below inflation, and worse than the return on cash.
Is the dividend safe?
A 9.3% dividend provides much greater protection against a falling share price than a 6.6% one. And the yield has not been at this level for the past 10 years.
Legal & General dividend yield for the year 2015-24
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Management is forecasting a 2% annual increase in the budget and additional cash to be distributed through share buybacks. But investors may initially wonder how Legal & General will fund this.
The company is currently paying out more cash to shareholders than it is bringing in as revenue. But while this may seem like a source of concern, it’s probably less dangerous than it first appears.
Statutory and ordinary dividends per share versus earnings per share in 2020-24
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At the end of 2023, Legal & General has more than £9bn of excess cash after meeting its Solvency Capital requirement. This should mean that the company is able to meet its ongoing dividend obligations.
Outlook
In terms of future growth, Legal & General’s main engine is its Pension Risk Transfer business. It takes guaranteed future pension obligations from other companies – in exchange for money.
Management is optimistic about a pipeline of new deals over the next few years. But investors must be clear that the quality is there and the price.
Getting money up front before paying expenses later is a good structure. But the deals have an asymmetric risk structure – the amount of Legal & General that can be done is adjusted while the potential liabilities remain the same.
Even including the returns that the company can make by investing in premiums, it will take a long time for the benefits of the contracts to become clear. And that’s where the danger comes in for investors.
A no-brainer?
As an investment, Legal & General shares are not foolproof. The nature of the firm’s potential liabilities means that there is a lot of uncertainty about the future, especially in the long term.
That’s why dividend yields are so high – investors need something to give them a margin of safety against ongoing risks. While 9.3% may be enough for some, I look elsewhere.
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