Legal & General (LSE: LGEN) shares were one of my first investments (many years ago), and I still have them.
They introduced me to the pleasure of receiving regular payments for doing nothing more arduous than just owning a stock.
This was called ‘passive income’ I found out, and I have been a big fan of the concept ever since.
Unlike out-and-out growth shares, stocks that pay dividends provide a return without having to sell them.
Those payments can pave the way for a much better quality of life, in my experience, and even early retirement.
How much can be made?
In 2023, Legal & General paid a total dividend of 20.34p. The shares are currently priced at £2.27, so that gives a yield of 9%.
£9,000 today – the same as I started with 30 years ago – invested at 9% would make £810 this year. So, over 10 years this would make an extra £8,100, provided the yield averaged the same.
Not bad certainly. But as I discovered early on thankfully, it could be a lot more than that through ‘dividend compounding’. This involves using the dividends paid to buy more of the shares that paid them.
In Legal & General’s case, doing this would make £13,062 extra after 10 years instead of £8,100.
30 years from now, if the yield averaged the same, £123,575 would have been added to the initial £9,000 investment. So the £132,575 investment pot would be generating £11,932 in dividends every year!
Strong core business?
To support this level of return long term, the company will need to be making good earnings and profits.
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, at its 12 June Capital Markets Event, it announced a 6%-9% compound annual growth rate target in earnings per share to 2027.
It is also aiming for £5bn-£6bn cumulative Solvency II operational surplus generation to that point.
And it intends to increase shareholder rewards. Part of this will be a 5% increase in dividends this year, followed by 2% a year to 2027. The other part will be its first share buyback (of £200m) this year, followed by further buybacks.
How does the share price look?
Of course, there is no point in making these big dividends if they are erased by big share price losses.
This is why I always buy shares that look undervalued compared to their competitors, as it reduces the chance of this happening.
Legal & General looks cheap to me trading at a price-to-book ratio (P/B) of 2.8 against a peer group average of 3.4.
I ran a discounted cash flow analysis to ascertain how cheap it is, using other analysts’ figures and my own. This shows the shares to be 58% undervalued at the current price of £2.27. Consequently, a fair value for Legal & General shares would be around £5.45.
This does not mean that they will reach that price, of course. But it signals to me that they are significantly undervalued.
If I did not already own the shares, I would buy them today. I think the company’s growth prospects, undervaluation, and high yield are too good to pass up.
