Dividend star Legal & General’s share price is down 11%, so should I buy more?

Legal & General’s share price looks very undervalued against its peers, pays a high dividend that is set to get higher, and has a strong core business.

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Legal & General’s (LSE: LGEN) share price has dropped around 11% from its 7 March 12-month high.

Like many financial firms around that period, the insurer and asset manager was hit by fears of another financial crisis. This followed the failures of Silicon Valley Bank and Credit Suisse.

No such crisis emerged, but Legal & General shares dropped 20% in two weeks from 8 March 2023. They have recovered 9% of their value since then, but they are still significantly down.

This looks like an opportunity for me to add to my existing stake in the firm.

Undervalued against its peers?

Just because shares have dropped in price does not mean they are undervalued. It could simply be that the company is worth less than it was before.

To ascertain whether it is undervalued, I started by comparing its price-to-earnings (P/E) ratio with those of its peers.

It trades at a ratio of 7.1. Prudential trades at 8.2, Hansard Global at 11.3, Admiral at 21.1, and Beazley at 31.9.

This gives a peer group average of 18.1, against which Legal & General’s 7.1 looks very good value indeed.

A discounted cash flow analysis reveals that the stock is around 58% undervalued. Therefore, a fair value would be around £5.71 a share, against the current £2.40. This does not necessarily mean it will ever reach that price, of course.

Does the business look strong?

H1 2023 results showed the firm is on track to achieve its end-2024 capital growth target of £8bn-£9bn. This huge war war chest should provide a major spur to expansion.

It is well positioned to do this in the UK Pension Risk Transfer (PRT) market, in which it is a leader. This market involves a company being paid by other firms to take over the running of their pension schemes.

It could also come from the US PRT sector, in which it is a top 10 provider. The US has enormous growth potential, as $3trn of defined benefit pension schemes have yet to be transferred.

One potential risk in the stock is its net debt-to-equity ratio, which is around 3.8. For companies in high-cash-flow businesses — like insurance and investment firms – anywhere up to 2.5 or so is considered healthy.

The risk here is mitigated in my view by very high earnings that allow it to comfortably service its debt interest. It has earnings before interest and taxes (EBIT) of 10.9x, compared to the 3x or above that is considered good.

Nonetheless, I would like to see its debt-to-equity ratio start to trend lower this year.

Additionally positive is that its Solvency II coverage ratio increased to 230% in H1 2023 (from 212% in H1 2022). A ratio of just 100% meets all the regulatory requirements for the insurance sector.

High dividend payer

Legal & General paid a 19.37p dividend in 2022, giving a yield of 8% on the current £2.40 share price.

But this should get even better. It has promised to increase the payout by 5% to the end of 2024. This would mean a 20.3385p payout, giving a yield of 8.5% on the present share price.

Given its high dividend and even higher forecast, its strong business, and its undervalued shares in my view, I shall be adding to my holding very soon.

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.

Simon Watkins has positions in Legal & General Group Plc. The Motley Fool UK has recommended Admiral Group Plc and Prudential Plc. 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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