FTSE 100 financial services firm Legal & General’s shares (LSE: LGEN) have dropped 11% from their 7 March high.
The key reason for the fall was the failure of Silicon Valley Bank, and then Credit Suisse, in my view. These catalysed fears of a new financial crisis. This did not happen, but Legal & General shares are still marked down.
The advent of a genuine new financial crisis does remain a risk for the stock, of course. Another is that inflation and interest rates stay high, deterring new client business.
However, I bought Legal & General shares some time ago for three key reasons and I think those reasons are still valid now.
My first is that they should continue to pay high dividends in the future. Second, the share price should gradually converge towards its fair value over time.
And third, these gains should continue to be driven by a strong core business.
Nothing has changed, in my view, and I am considering buying more of the stock before 2024 begins.
Core business positioned for growth
Legal & General’s core business looks strong to me and is in a high-growth market.
Its retirement solutions operation is a market leader in the UK Pension Risk Transfer (PRT) space. This is where a company takes over other companies’ pension scheme commitments for a guaranteed return from them.
It is also in the top 10 in the US PRT market, which has exceptional growth potential. Only around 9% of the US’s $3trn of defined benefit pension schemes have been transferred so far.
Legal & General Investment Management is also a leading global asset manager. It is ranked 11th in the world, with £1.2trn of assets under management.
Its H1 results showed it has generated £5.9bn of capital from the start of its five-year plan in 2020. And it is on track to achieve its target of £8bn-£9bn by the end of 2024, according to the company.
Undervalued compared to its peers
On a price-to-earnings (P/E) basis, Legal & General is the cheapest in its peer group, trading at 7.1.
Prudential is at 8.9, Hansard Global at 10.3, Admiral at 22.8, and Beazley at 29.6. This gives a peer group average of 16.9.
To determine what a fair price for the company’s shares might be, I applied the discounted cash flow (DCF) model. Given the assumptions involved in this, I used several analysts’ valuations as well as my own.
The core assessments for the company range between 48% and 52% undervalued. The lowest of these would give a fair value per share of £4.62 compared to the current £2.40.
This suggests to me that the shares are very good value indeed.
Big dividends for investors
In 2022, Legal & General paid a total dividend of 19.37p per share. Based on the current share price, this gives a yield of 8%.
However, in its H1 results, it said it will increase the payout by 5% to the end of 2024. This would mean a yield of 8.5% this year, based on today’s price. Next year, it would mean a payout of 8.9% on the same basis.
An 8.9% yield average over 10 years would add £8,900 to an initial £10,000 investment.
