Should I buy Direct Line shares for its 7.5% dividend yield?

Direct Line shares rose about 15% in the past year. It has a 7.5% dividend yield. Royston Roche reviews the stock to see if it’s a good fit for his portfolio.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Direct Line Insurance (LSE: DLG) shares are up about 15% in the past year, so do I think this rise can continue? OK,  insurance businesses aren’t like fast-growing US technology stocks. But their potential stable dividend income and long-term stock appreciation is appealing. So would I buy?

Why I might consider buying Direct Line shares

Direct Line’s recent financial results have been good in a challenging period. For 2020, its gross written premium figure was down only marginally (by 0.7%) year-on-year to £3.2bn. And the combined operating ratio (COR) improved to 91% in the year 2020 from 92.2% in the previous year. This is one of the important metrics when assessing an insurance stock. The COR is the sum of claims, expenses and commission ratios. A COR of less than 100% indicates profitable underwriting. And Direct Line has hit this target in the past five years. 

Inflation Is Coming

Inflation is out of control, and people are running scared. But right now there’s one thing we believe Investors should avoid doing at all costs… and that’s doing nothing. That’s why we’ve put together a special report that uncovers 3 of our top UK and US share ideas to try and best hedge against inflation… and better still, we’re giving it away completely FREE today!

Click here to claim your copy now!

The company has also resumed its dividend, which is another reason why I like the stock. For the 2020 financial year, it paid an interim dividend of 7.4p, plus a special dividend of 14.4p to compensate for the cancelled 2019 final payout. The company is also paying the final dividend of 14.7p for 2020 today. At the current share price, the dividend yield is about 7.5%, which is very attractive. However, I understand that there’s no guarantee the company will continue to pay future dividends. 

Yet I hope it will. It has a stable balance sheet, a solvency capital ratio of 191% and has maintained a capital surplus above the regulatory capital requirement. The net cash generated from the operating activities improved to £584.7m for the year 2020 from £462.1m for 2019. I like companies with good operating cash flows as I consider them to be a safer bet during any economic downturns.

The downsides

The insurance sector is very competitive. This is one reason why I get nervous when judging insurance stocks. Online premium comparison sites have made matters worse for insurance companies’ profits. Also, businesses like Direct Line are being advised by the Financial Conduct Authority that they must not charge their existing clients more than new ones for insurance policies. This, in my opinion, could put a dent in its profits. 

And the lockdown has reduced the number of new vehicles registered. People have reduced their travel and this will have a negative impact on the motor insurance business. This impact could be seen in DLG’s most recent trading update. The motor insurance segment’s gross written premium fell by 11% year-on-year to £367.3m. 


Yet the company is fundamentally strong. It’s trading at a price-to-earnings ratio (P/E) of 11.5, lower than its five-year average of 12.1. So, I feel the shares are not trading at a significant enough discount to their historical average for me. I’ll keep the stock on my watch list, but I’m not a buyer today. I prefer another insurance stock, Aviva, that’s trading at a lower P/E ratio than Direct Line shares.

FREE REPORT: Why this £5 stock could be set to surge

Are you on the lookout for UK growth stocks?

If so, get this FREE no-strings report now.

While it’s available: you'll discover what we think is a top growth stock for the decade ahead.

And the performance of this company really is stunning.

In 2019, it returned £150million to shareholders through buybacks and dividends.

We believe its financial position is about as solid as anything we’ve seen.

  • Since 2016, annual revenues increased 31%
  • In March 2020, one of its senior directors LOADED UP on 25,000 shares – a position worth £90,259
  • Operating cash flow is up 47%. (Even its operating margins are rising every year!)

Quite simply, we believe it’s a fantastic Foolish growth pick.

What’s more, it deserves your attention today.

So please don’t wait another moment.

Get the full details on this £5 stock now – while your report is free.

Royston Roche has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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 considered, so you should consider taking independent financial advice.

More on Investing Articles

Portrait of construction engineers working on building site together
Investing Articles

Is this FTSE 100 stock the best housebuilder to invest in?

One FTSE 100 housebuilding stock has outperformed all of its industry peers by a big margin this year. Should I…

Read more »

pensive bearded business man sitting on chair looking out of the window
Investing Articles

2 cheap dividend growth stocks I’d buy as the economy sinks

I'm searching for the best bargains to buy following recent market volatility. Here are two top dividend growth stocks I…

Read more »

estate agent welcoming a couple to house viewing
Investing Articles

Here’s 1 FTSE stock primed to benefit from the current housing market!

With the current housing market as it is, Jabran Khan explores a related FTSE stock that could provide stable and…

Read more »

Portrait of construction engineers working on building site together
Investing Articles

Here’s why this AIM-listed stock could be one of the best shares to buy!

This Fool is looking for the best shares to buy. Despite macroeconomic issues, this stock could be a great long-term…

Read more »

Elderly father and adult son work in the garden
Investing Articles

This penny stock could be set to soar! Should I buy shares?

This Fool looks closely at a penny stock operating in an exciting growth market that could see its shares rise…

Read more »

Illustration of bull and bear
Investing Articles

The next stock market recovery looks imminent

As the stock market bear gives way to the bull, some stocks are already turning up and I'm ready to…

Read more »

Young mixed-race woman looking out of the window with a look of consternation on her face
Investing Articles

2 dividend shares to protect me from soaring inflation

Dividend shares can be an excellent way to keep up with inflation. Our writer explores several options to protect his…

Read more »

Middle-aged white man pulling an aggrieved face while looking at a screen
Investing Articles

Is it time to buy Unilever stock?

Unilever stock has underperformed in the last five years. But with its portfolio of powerful brands, should I buy now…

Read more »