Buying dividend shares is arguably one of the simplest ways to generate extra cash outside of my main source of income.
I already own these two. But at their current prices, I plan to top up. Here’s why.
Legal & General
Candidate number one is Legal & General (LSE: LGEN). Since buying shares in the insurance stalwart since last year, I’m up 16.7%. However, at 256p, I see room for more growth. That’s because I think it looks undervalued. As I write, the shares trade on a price-to-earnings (P/E) ratio of around seven.
To add to that, the stock yields 7.7%, one of the highest yields available on the FTSE 100. What’s more, the firm has shown its willingness to give back to shareholders through its cumulative dividend plan. This has been in motion since 2020 and is set to end this year. As part of it, Legal & General is on target to return up to £5.9bn to shareholders.
It’s impressive, but I’m wary of potential risks. Namely, a weak economic outlook for the foreseeable future will impact client demand. We saw this in action last year as its assets under management wavered.
However, over the next two to three years I’d expect the economic outlook to strengthen. I think Legal & General is well placed to capitalise.
Lloyds
Candidate number two is Lloyds (LSE: LLOY). Unlike Legal & General, I’m down slightly with Lloyds. But I’m still bullish on the long-term outlook.
That’s especially since its stock now sits at 43p, having had a slow start to 2024. But it yields 5.9%. It’s forecast to rise to 8.5% over the next three years.
The case of Lloyds is rather frustrating. For years, investors have been waiting for its share price to show some upward movement. However, we’re still waiting for that day. I’m hopeful, however, that we’re nearing it.
Its recent run-in with the Financial Conduct Authority won’t help its cause. But I see plenty to like about Lloyds. Its shares look cheap, trading on a P/E ratio of 7.7. On top of that, its price-to-earnings-to-growth ratio, which is calculated by dividing a company’s P/E ratio by its forecast earnings per share growth rate, is around 0.5. That shows the stock may be undervalued by half.
Of course, the firm faces a tough few months ahead. Yet when interest rates fall, as the UK’s largest mortgage lender, Lloyds will also get a boost. From there, I think it could take off.
Key considerations
While I like the look of these stocks, I’m cautious on a few points.
First, dividends are never guaranteed. Companies can reduce dividends or cut them altogether. We saw this in 2020 with the pandemic.
On top of that, a high yield isn’t always a good thing. Instead, it can signal issues. Take Vodafone as an example. The business provides the highest payout on the FTSE 100. However, that’s largely because its share price has fallen drastically in recent times. As such, the sustainability of its dividend is questionable.
That said, by doing sufficient research, I’m confident I can find shares that will provide me with stable passive income in the coming years. With this money, I plan to use it for a more comfortable retirement, whenever that day arrives!
