I bought M&G (LSE: MNG) shares in March when they yielded more than 9% a year, giving me a spectacular second income stream. After this week’s dip, the FTSE 100 asset manager’s shares offer even more income.
The stock is now forecast to yield a staggering 10.4% this year, which will excite some while ringing alarm bells among others. Double-digit yields are tempting, but notoriously risky.
I’m taking a chance here
I fell for two last autumn – housebuilder Persimmon and mining giant Rio Tinto. Both have subsequently slashed their dividends, by 75% and 50% respectively. Yet most investors, including me, saw that coming. I’m still up by around 10% or so, while today’s yields still look halfway decent at 4.92% and 8.22% respectively.
At first glance, M&G’s dividend looks similarly doomed as the company actually made a £1.62bn loss last year. However, the reason was fairly technical, down to non-cash losses in the fair value of its surplus annuity assets and from derivatives used to hedge its Solvency II balance sheet, triggered by rising yields.
I’m more worried by last year’s plunge in capital generation, from £1.87bn to a negative £397m. However, that didn’t stop management from increasing the dividend by 7.1% to 19.6p per share, and rewarding loyal shareholders with a £503m share buyback. Better still, M&G hopes to generate £2.5bn of capital this year.
If it can dispense largesse in the bad times, I don’t see why it should cut back as its capital recovers, although I’m not privy to board decision-making.
Markets expect M&G to generate net income of £412m this year, rising to £473m in 2024. The stock is cheap, trading at a forward P/E of 11.3 times earnings, then 9.82 times in 2024. Net debt remains a worry though. At £7.5bn, it dwarfs the company’s £4.53bn market-cap.
Scary but tempting
The M&G share price is down 3.66% over the last week and 11.86% over 12 months, and I sniff an opportunity as investors run scared of the US debt ceiling row.
I’m really keen to take advantage of today’s high yield and low valuation. If I invested my full £20,000 Stocks and Shares ISA allowance in M&G at today’s share price of 192.30p, I’d have 10,400 shares. If management holds the 2023 dividend at the 2022 level of 19.60p per share (it could increase it), my £10k stake would give me income of £2,038 a year.
That’s a dizzying income but given the risks I’ve outlined, I’m not brave enough to invest my full ISA allowance in M&G. I’ll spend too much time fretting over whether management follows Persimmon and Rio Tinto in hacking the dividend.
What M&G really needs now is a bull market, to boost investor confidence and get the cash flowing into its funds again. I’d like to invest before that happens, to reap the benefit of the recovery (whenever it comes).
By investing £5,000 I can avoid being too overweight on M&G and still generate a second income of more than £500 a year. There are risks, but the potential rewards are worth it. I’ll buy.
