Legal & General (LSE: LGEN) shares have long been one of my top performers for paying big dividends. In recent months, I have also benefited from a substantial gain in the share price. And I believe both profit streams will continue in abundance for some time to come.
A hugely undervalued share price still?
A share’s price and its value are not the same thing at all. The former is whatever the market will pay for a stock at any given time. The latter is what it is worth, based on the underlying business fundamentals.
Being able to spot the difference and put a number on it are the keys to big profits, in my experience. This comprises several years as a senior investment bank trader and decades as a private investor.
A core part of differentiating price from value is to look at a company’s earnings (profit) potential. It is growth here that powers any firm’s share price and dividends over time.
A risk for Legal & General is a further surge in the cost of living, which could cause investors to cancel their policies. That said, analysts forecast that its earnings will increase by a stunning 26.7% a year to end-2027.
I believe the optimal way of translating such growth into a share price forecast is through the discounted cash flow (DCF) model. This pinpoints where any firm’s stock price should be, as derived from cashflow projections for the underlying business.
The DCF for Legal & General shows its shares are 55% undervalued at their present £2.54 price. Therefore, the fair value is £5.64.
Is the dividend yield set to rise as well?
The financial services giant paid a dividend last year of 21.36p. This generates a yield on the present share price of 8.4%. This is more than double the FTSE 100’s average yield of 3.6%. However, analysts forecast the dividend will rise to 21.7p this year, 22.2p next year, and 22.6p in 2027. Based on the current share price, this would generate respective yields of 8.5%, 8.7% and 8.9%.
Eleven thousand pounds (the average UK savings amount) in the shares at an 8.9% yield would make £15,699 in dividends after 10 years. After 30 years on the same basis, this would rise to £146,282.
The total value of the holding at that point (including the initial £11,000) would be £157,282. And this would generate an annual dividend income of £13,998!
These figures are based on the dividends being reinvested back into the stock – known as dividend compounding.
Does an investor need a lot to start with?
It is a common misconception that making life-changing annual dividend income requires big capital to begin with. In fact, small sums invested regularly can provide a huge nest egg over time.
For example, £5 a day invested in Legal & General at the projected yield of 8.9% will make £11,078 in dividends after 10 years. After 30 years on the same basis, this will rise to £216,951, with the holding’s value (including deposits) being £270,951by then. This would generate a yearly dividend income of £24,115!
Given its extremely strong earnings prospects, very undervalued share price, and excellent yield I will buy more of the shares very soon.
