Insurer and financial services company Legal & General (LSE: LGEN) is popular with many income investors due to its dividend. At over 6%, it offers well above the average FTSE 100 dividend yield. Here I explain why I find the Legal & General dividend attractive and what might happen to it in future.
Insurers as UK income stocks
Insurers often generate free cash flow which they can use to pay dividends. So it is no coincidence that many insurers have attractive dividends. For example, as well as Legal & General itself, Direct Line yields 7.2%, while Admiral offers 3.5%.
Paying out cash as dividends means there is less to reinvest for future growth. But despite its generous payout level, the Legal & General dividend has been more than covered by earnings in recent years. So, the dividend doesn’t preclude a growing business. Indeed, Legal & General was growing revenue and profits in the years before the pandemic.
Why I like the Legal & General dividend
The share price growth of 23% in the past year accounts for most of the growth in the past five years of 30%. That’s still decent capital growth, but it’s not as good as many top UK stocks. That is why I see Legal & General as an income rather than capital choice for my portfolio. While the share price may continue to grow, it is the income potential that attracts me.
During the pandemic, most insurers bowed to pressure to cut their dividend. Unlike rivals such as Aviva, Legal & General continued to pay out, although it did keep the dividend flat for a year instead of raising it as it had been doing. That underlines that the company considers the interests of shareholders closely. While that doesn’t guarantee future payouts, I do find it reassuring.
The Legal & General dividend plan
Some companies have a stated dividend policy they try to implement. Legal & General has gone so far as to lay out a five-year plan for its dividends. At its capital markets event last year, it outlined its plan to pay £5.6bn–£5.9bn out in dividends in the following five years. For perspective, in 2020 Legal & General’s dividend costs totalled £1.0bn. So the current policy suggests a modest annual increase in dividends in years to come.
The company also said it was focussed on growing earnings per share faster than dividends. Cash and capital generation ought to exceed dividends significantly. I see that as positive, because it means the dividend will remain comfortably covered. I prefer a dividend rising due to improving business results, rather than increases supported only by cutting dividend coverage levels, as that is ultimately unsustainable.
Legal & General dividend increase
We saw the plan in action yesterday, when the company announced its interim results. The interim dividend of 5.18p was 5% higher than last year. 5% might not sound a lot, but I regard it as a substantial dividend increase. If a dividend was raised 5% each year, it would double within fifteen years.
In line with the dividend policy, I expect the company to raise its dividend in low to mid single percentage points for each of the coming four years. However, dividends are never guaranteed. There is always the risk that a downturn in business results and earnings could lead to a dividend cut. The Legal & General dividend was cut after the last financial crisis, for example.
Christopher Ruane has no position in any shares mentioned. The Motley Fool UK has recommended Admiral Group. 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.