FTSE 100 investment manager M&G (LSE: MNG) is down 17% from its 21 March 12-month traded high of £2.41.
One reason for this was the usual financial market jitters ahead of the 4 July UK general election. Following that, uncertainty has arisen over whether the Labour government intends to increase capital gains tax.
This could affect net flows of investment managers such as M&G, so it remains a principal risk for the firm.
That said, as yields rise when share prices fall, the company is now paying a dividend return of 9.8%. This compares to the current FTSE 100 average yield of 3.7%.
Big passive income returns
So, investing the average amount of UK savings (£11,000) in M&G shares would make £1,078 in the first year.
The same amount would accrue every year, if the yield averaged the same and the dividends were removed from the investment account.
Doing it this way would mean an extra £10,780 after 10 years, and an additional £32,340 after 30 years.
This is a lot better than even the best savings rates currently available in UK banks. However, it is nothing compared to what could be made if ‘dividend compounding’ was used.
The power of dividend compounding
This simply involves using the dividends paid to buy more of the shares that paid them – in this case, M&G.
On this basis and an average yield of 9.8%, after 10 years a further £18,193 would have been made, not £10,780.
And after 30 years, the additional amount generated would be £194,605 rather than £32,340!
At that point, the total investment in M&G would be worth £205,605. And that would pay £20,149 a year in dividends!
How does the share price look?
To mitigate the risks of the dividends being wiped out by share price losses, I look for stocks that appear undervalued.
M&G shares currently trade on the key price-to-book ratio (P/B) at just 1.1 against a competitor average of 3.5.
This looks a bargain, so I ran a discounted cash flow analysis to find out how cheap it is exactly.
Using other analysts’ figures and my own, this shows the shares to be 56% undervalued at their present £2.01 price.
Therefore, a fair value for the shares would be £4.57, although this is no guarantee that they will reach that.
Is the business set for growth?
M&G is in the first year of its ‘Transformation’ programme aimed at increasing its financial strength, simplifying the business and unlocking growth.
On the first of these targets, 2023 saw its adjusted operating profit before tax jump 28% year on year to £797m.
On the second, it restructured its Private Markets team and reduced its consultancy and contractor spend by 11% last year. This led to cost savings of £73m.
And on the third, it re-entered the Bulk Purchase Annuity market, completing two deals with a combined premium of £617m. It signed a third deal with a £309m premium on 15 March this year. Additionally, it forecasts £1bn-£1.5bn in sales in this sector each year going forward.
Consensus analysts’ estimates are that its overall earnings will increase 18.5% every year to end-2026.
Given its exceptional yield, extreme undervaluation, and excellent growth prospects, I will be adding to my existing holding in the firm very soon.
