8.1% dividend yield! Should I buy this dirt-cheap FTSE 100 stock?

Dr James Fox takes a closer look at a FTSE 100 stock paying shareholders an impressive 8.1% dividend yield. Is it a stock worth buying?

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Legal & General (LSE:LGEN) has one of the strongest dividend yields on the FTSE 100. With the share price falling in recent weeks, the financial services giant now offers shareholders an 8.1% dividend yield.

But as we know, big dividend yields can be a warning sign. So should investors be piling into L&G for these strong returns, or is this one to avoid?

Strong business

Legal & General isn’t a waning stock or an underperforming business. The multinational financial services and asset management company posted an operating profit of £2.52bn in the year to December 31, up 12% year on year, and beating consensus expectations of £2.46bn.

Retail operating profit increased 33% to £825m, but investment arm LGIM saw operating profit fall to £340m from £422m. The dipping operating profit within LGIM was put down to the impact of market movements on assets under management.

But the business’s strong performance in general led to a 5% increase in the full-year dividend.

High yield, low P/E

As noted, Legal & General offers one of the strongest dividend yields on the index. The coverage is also solid. The dividend coverage ratio (DCR) — a financial metric that measures the number of times a company can pay dividends to its shareholders — is 1.98.

Broadly speaking, a coverage ratio around two is considered healthy. Legal & General’s DCR shows that it could pay its shareholders the stated dividend almost twice from net income.

Legal & General also trades with a low price-to-earnings (P/E) ratio — 6.2. That’s around half the index average, and suggests either something is wrong, or it’s just a cheap stock. In this case, it’s mainly the latter.

However, it’s also worth noting that companies with higher P/E ratios tend to trade at such levels because they offer greater growth potential.

Legal & General doesn’t offer too much in the way of growth — although I’m purchasing more stock now as I like to buy during a dip. The thing is annualised total returns of the FTSE 100 is around 8-9%. Essentially, with its sizeable yield, Legal & General offers most of its returns in the form of dividends.

Well, I’ve bought more of this stock recently after the share price pushed downwards. The market correction was engendered by the Silicon Valley Bank fiasco, not any change in the macroeconomic environment or business’s performance.

Personally, I like steady, dividend-paying stocks as the core part of my portfolio. And there are few that are as steady as Legal & General. The dividend is secure with strong coverage, and I’m expecting to see some upward movement in the share price from this artificially low point.

Of course, nothing is guaranteed — not even this dividend — and I appreciate that challenging bond market conditions could pose risks. However, for me, Legal & General is an excellent company and one I’m happy to have in my portfolio.

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.

James Fox has positions in Legal & General Group Plc. 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.

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