FTSE 100 investment management firm M&G (LSE: MNG) is rarely among the top-traded stocks on the leading index. Instead, it goes quietly about its business and religiously pays out its sizeable dividends.
And that is exactly what I want in a share I buy for its passive income potential. This is money made with minimal daily effort, most notably in my view from dividends paid by shares.
The core business
I hold M&G shares in my portfolio. In 2023 its year-on-year adjusted operating profit jumped 28% to £797m. Over the same period, its operating capital generation leapt 21% to £996m.
And its key Shareholder Solvency II coverage ratio rose from 199% to 203%. A ratio of 100% is the industry’s regulatory standard.
Its H1 results showed a 4% drop in adjusted operating profit over the same period in 2022 to £375m. Its operating capital generation saw just under the same level of decline to £486m. However, its Shareholder Solvency II coverage ratio improved to 210%.
A risk here is the high level of competition in the sector that may reduce the firm’s profit margins. Another is a resurgence in the cost of living which may cause investors to close their accounts.
However, consensus analysts’ expectations are that M&G’s earnings will grow a stunning 28.9% a year to end-2026. And it is earnings growth that drives a firm’s dividend and share price higher over time, in my experience.
How does the share valuation look?
The stock already looks deeply undervalued to me based on some key measures I most rely on.
On the price-to-book ratio, it trades at just 1.3 against a competitor group average of 3.6. On the price-to-sales ratio it is currently at 0.8 compared to a 4.3 average for its competitors.
Most important to me always in attempting to detect undervalued stocks is the discounted cash flow (DCF) analysis.
A DCF using other analysts’ figures and my own shows M&G shares are 55% undervalued at their present price of £2.02. So a fair value for them would be £4.49.
They may go lower or higher than that, given the vagaries of the market. However, it confirms to me how undervalued the stock looks at this moment.
This reduces the chance of my dividend gains being dented by share price losses should I ever sell the stock.
How much passive income could I make?
I already have a sizeable holding in M&G but am considering adding another £5,000 to it. At today’s price, this would buy me 2,475 additional shares.
With the stock now giving a yield of 9.9% (compared to the FTE 100 average of 3.6%) this would make me £8,402 in dividends after 10 years.
This is provided I buy more stock with the dividends paid to me and the dividend is not cut. It is a common investment practice known as ‘dividend compounding’.
On the same average 9.9% yield, I would have made £91,279 in dividends after 30 years.
Adding in the initial £5,000 investment, my M&G shares would be worth £96,279 by then. And they would be generating £9,532 a year in passive income for me, or £794 each month.
Given the stock’s high earnings growth potential, deep undervaluation, and enormous passive income potential, I will be buying additional shares very soon.
