£11,000 of Legal & General shares can make me £801 a month in passive income!

Legal & General shares look very undervalued and could possibly make me big passive income over time, especially if my dividends are reinvested.

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Legal & General (LSE: LGEN) shares have long been a core holding in my high-yield portfolio. This has been constructed to pay me as much passive income as possible, so I can continue to cut down on my workload.

How much can I make?

In 2023, the firm increased its dividend by 5%, to 20.34p. On the current share price of £2.50, this gives a yield of 8.1%.

So £11,000 — the average savings amount in the UK — invested at 8.1% would make £891 this year in dividends payments.

If the yield averaged the same over 10 years, the dividends would be £8,910 on top of the £11,000 investment.

Crucially however, these returns could be turbo-charged by reinvesting the dividends paid back into the stock. This is known as ‘dividend compounding’ and is the same process as compound interest in a bank account.

If this was done, then I would have an additional £13,660 instead of £8.910 after 10 years. This would mean £24,660 in total, paying £1,913 a year in dividends, or £159 a month.

Over 30 years on an average 8.1% yield, the investment pot would total £123,932, paying £9,612 a year, or £801 a month.

Achieving even more from £0

Surprisingly to many perhaps, the same can be achieved from a starting point of £0 in the bank.

Investing just £5 a day — £150 a month – in 8.1%-yielding Legal & General shares would produce £27,782 after 10 years. This is also provided that the dividends are reinvested back into the stock.

After 30 years on the same basis, the total would be £229,685. This would pay £17,748 a year, or £1,479 every month in dividend payments.

Can these high returns be sustained?

Growth in earnings and profits drives increases in a company’s share price and its dividends over time.

One risk in the company is that its 3.8 debt-to-equity ratio is higher than the 2.5 or so considered healthy for investment firms. Another is a new global financial crisis.

However, Legal & General made an operating profit last year of £1.67bn, against 2022’s £1.66bn.  It has forecast cumulative Solvency II capital generation of £8bn-£9bn by the end of this year. These are strong capital buffers for the future.

Consensus analysts’ expectations are now for its earnings to grow by 22.9% a year to the end of 2026.

Do the shares look undervalued?

The company currently trades at 3.1 on the key price-to-book (P/B) measurement of stock value. This compares to a peer group average of 3.5, so it is cheap on that basis.

It also looks cheap at its price-to-sales (P/S) ratio of just 1.2, against a competitor average of 1.6.

But how cheap exactly? A discounted cash flow analysis using several analysts’ figures and my own reveals it to be around 58% undervalued at the current price of £2.50.

Therefore, a fair value would be around £5.95, although this does not guarantee it will ever reach that price.

However, being so undervalued does reduce the chance of a sustained major share price fall wiping out my dividend gains.

Given their high yield, apparent undervaluation, and growth prospects, I am looking to buy more Legal & General shares shortly.

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 no position in any of the shares mentioned. 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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