How Safe Is Your Money In Legal & General Group Plc?

Could Legal & General Group Plc (LON:LGEN) cope with a run of bad luck without cutting its dividend?

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MondiThe insurance sector has undergone a fantastic re-rating over the last year. While the FTSE 100 is only 4% higher than it was in March 2013, Legal & General Group (LSE: LGEN) (NASDAQOTH: LGGNY.US) has gained 42%, while Aviva is up 60% and Prudential has risen by 35%.

Legal & General’s 2014 prospective yield of 4.5% is the highest of these three firms, making it a popular choice with income investors. However, after such a long run of growth, it’s more important than ever to look for potential pitfalls.

Using three financial ratios of the kind often used by credit rating agencies, I’ve taken a closer look at Legal & General’s latest results to see if I can spot any potential red flags.

1. Operating profit/interest

What we’re looking for here is a ratio of at least 1.5, to show that Legal & General’s operating earnings cover its interest payments with room to spare:

Operating profit from business units / group finance costs

£1,329m / £127m = 10.5 times cover

Legal & General’s operating profits cover its interest payments (those related to its business, not investments) by more than 10 times, so there’s no problem here.

2. Debt/equity ratio & cash generation

Commonly referred to as gearing, this is simply the ratio of debt to shareholder equity, or book value (total assets – total liabilities).

Legal & General’s corporate debt levels are very modest, and the firm had debts of just £3.2bn at the end of 2013, offset by cash and cash equivalents of £17.4bn, which give a net cash position of more than £14bn.

The firm’s ability to generate cash is impressive — in 2013, Legal & General generated surplus cash of more than £1bn, easily covering interest and dividend payments.

3. Return on equity

Return on equity (RoE) is a useful way to measure the performance of financial firms, as it shows how much profit was generated compared to the book value (equity) of the firm.

An RoE of 15% or above is desirable, and Legal & General generated a RoE of 16% in 2013, up from 15% during the previous two years.

How safe is Legal & General?

Trading on a trailing P/E of 15.5, Legal & General’s shares aren’t cheap at the moment, but the firm’s size, cash generation, and well-covered dividend, should make it a very safe long-term buy, regardless of any short-term issues that might arise.

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 owns shares in Aviva, but does not own shares in any of the other companies mentioned in this article.

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