Does Legal & General Group Plc Pass My Triple Yield Test?

Roland Head rates Legal & General Group Plc (LON:LGEN) as one of the best income stocks in the financial sector, but is the price right?

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fivepoundcoinsLike most private investors, I drip feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.

However, the FTSE 100 is up 72% on its March 2009 low, and the wider market is no longer cheap — it’s getting harder to find shares that meet my criteria for affordability.

In this article, I’m going to run my investing eye over Legal & General Group (LSE: LGEN) (NASDAQOTH: LGGNY.US), to see if it might fit the bill.

The triple yield test

Today’s low cash savings and government bond rates mean that shares have become some of the most attractive income-bearing investments available.

To gauge the affordability of a share for my income portfolio, I like to look at three key trailing yield figures — the dividend and earnings yields, and the return on equity. I call this my triple yield test:

Legal & General Value
Current share price 222p
Dividend yield 3.6%
Earnings yield 6.5%
Return on equity 16.2%
FTSE 100 average dividend yield 2.9%
FTSE 100 earnings yield 5.8%
Instant access cash savings rate 1.5%
UK 10yr govt bond yield 2.7%

A share’s earnings yield is simply the inverse of its P/E ratio, and makes it easier to compare a company’s earnings with its dividend yield. Legal & General’s earnings yield of 6.5% equates to a trailing P/E ratio of 15.4, slightly cheaper than the FTSE 100 average of 17.2.

Legal & General’s return on equity of 16.2% indicates strong profitability, and although the firm’s 3.6% dividend yield is already comfortably above the FTSE average of 2.9%, Legal & General shareholders may be about to receive a generous pay rise: the company’s interim payout rose by 22% this year, and analysts’ forecasts suggest that the firm’s final dividend will rise by a similar amount, giving a prospective yield of 4.2%.

Is Legal & General a buy?

Like many financial stocks, Legal & General was forced to cut its dividend in 2008 and 2009, but the dividend was never cancelled, and even including the cuts, Legal & General’s dividend has risen by an average of 5.1% per year since 2007.

Legal & General’s earnings are expected to have risen by 15% in 2013, but earnings growth is expected to halve to around 8% in 2014. It’s worth remembering that Legal & General shares are currently trading within 10p of their all-time high, and don’t look especially cheap on a prospective P/E of 14.2.

I believe there may be better buying opportunities later this year, so rate the shares as a hold.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Roland does not own shares in Legal & General.

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