Legal & General’s (LSE: LGEN) share price is still significantly lower than its level of early March 2023.
Back then it dropped around 20% in two weeks, as did several UK financial firms, on fears of a new financial crisis. The failures of Silicon Valley Bank and then Credit Suisse prompted these concerns.
The crisis never came, but many of these stocks stayed low and I have bought several of them.
In my view, the entire sector is undervalued against its European equivalent. This issue began after the 2016 Brexit vote and the mini-crisis of March 2023 made it more pronounced.
Strong capital base
A genuine new financial crisis does remain a risk for the sector and for Legal & General in particular. But this is mitigated by the strengthening of these firms’ capital bases that happened after the 2007 financial crisis.
Many now have Solvency II ratios of 200%+, against a regulatory standard of 100% — Legal & General’s is 230%.
Another risk is that debt ratios continue to climb past a safe level. Many UK financial sector firms finance expansion through debt rather than equity, as debt is generally cheaper.
This makes sense for them, as their business generates high levels of cash that makes these obligations relatively easy to service.
Legal & General’s debt-to-equity ratio is 3.8, against the 2.5 or so considered healthy for insurance and investment firms. I’d like to see this trending lower over the next three years.
However, it is on track to generate cumulative Solvency II capital of £8bn-£9bn by the end of this year. Additionally, analysts’ estimates are that earnings will grow by 24% a year to end-2026.
This should also enable it to keep paying high dividends, in my view.
A top dividend payer
Few companies in the FTSE 100 pay yields of 8% or more, but Legal & General is one.
It increased its dividend in 2023 by 5%, to 20.34p. On the current share price of £2.47, this gives a yield of 8.2%.
If I invested £10,000 now in the stock, then I would make £820 this year in dividends. If the yield averaged the same over 10 years, and I reinvested the dividends, I would have £22,642.
Over 20 years, on the same basis, this would grow to £51,265, and after 30 years to £116,073.
That would pay me £9,108 a year in dividends, or £759 a month!
Undervalued against competitors?
Of course, there is not much point in receiving high dividends if these gains are then wiped out by share price losses.
This is why I only buy high-dividend-paying stocks that also look undervalued against their peers to me.
Legal & General currently trades on the key price-to-book (P/B) measurement of stock value at 3. This compares to a peer group average of 3.4, so it looks cheap on that basis.
How cheap? A discounted cash flow analysis reveals that the stock is around 59% undervalued.
Therefore, a fair value would be around £6.02 a share, against the current £2.47. This does not necessarily mean it will ever reach that price, of course.
But it does indicate to me that it is very good value, as well as paying very high dividends.
So, on that basis, I will be buying more of the stock very soon.
