The share price of financial services company Legal & General (LSE: LGEN) plunged in March along with the banks. Indeed, the whole financial sector is weak right now.
And with the shares near 229p, they’ve fallen by almost 13% since 7 March. But in the context of the well-reported problems in the bank sector, the move makes sense.
After all, when banks start getting into trouble, the big fear is that a period of economic contraction may be on the way. And if the wheels fall off the global economy, banks and financial businesses like L&G could see falling profits.
A tempting valuation
However, that gloomy scenario is not a certain outcome. And it’s even possible that economies could improve from where they are now. But if that happens, the tempting valuation indicators we’re seeing with L&G may be a gift for investors.
The company released a robust set of full-year results in early March – just before the plunge in the share price. And the outlook statement was bullish.
And to put the recent fall in context, the shares are about 15% lower than they were a year ago.
The stock screams ‘value’ when looking at the traditional valuation indicators. For example, the forward-looking earnings multiple for 2024 is just over six. And the anticipated dividend yield is just over 9%.
City analysts haven’t registered any major signs of distress in the business… yet. They’ve pencilled in a high-single-digit drop in earnings this year followed by a full rebound in 2024. And they’re predicting rises in the shareholder dividend for this year and next.
Meanwhile, the price-to-tangible-book-value figure is running just below 1.2. And that looks undemanding.
But cyclical businesses like this tend to appear cheap on traditional valuation measures after a multi-year period of strong profits. The stock market dares not mark those valuations higher for fear of the next cyclical plunge in profits.
And unfortunately, a low-looking valuation tends not to save investors. For example, LGEN looked cheap three weeks ago – immediately before the 13% plunge.
Tempting but risky
But the cyclical cogs of the economy may yet turn to pull the rug from under profits. And that’s despite the diversified business model and the company’s stated prospects for growth.
Nothing’s certain, of course. Perhaps the robust outlook for the business will play out as the directors expect. And if so, the dividend stream may be worth having. Although I’m not expecting much of a valuation re-rating higher. And that’s because of the cyclicality in the sector.
Yes, the stock’s dividend yield is high. But is it too high and therefore more of a warning than an opportunity? It may be. After all, when and if the profits of cyclical companies plunge in a real economic crisis, share price movements can be brutal.
For example, L&G saw its stock plunge to around 30p in 2009. So, in conclusion, it looks tempting right now and may prove to deliver sound returns for investors. But the business comes with undeniable risks.
