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Does Legal & General Group Plc Pass My Triple Yield Test?

fivepoundcoinsLike most private investors, I drip feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.

However, the FTSE 100 is up 72% on its March 2009 low, and the wider market is no longer cheap — it’s getting harder to find shares that meet my criteria for affordability.

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In this article, I’m going to run my investing eye over Legal & General Group (LSE: LGEN) (NASDAQOTH: LGGNY.US), to see if it might fit the bill.

The triple yield test

Today’s low cash savings and government bond rates mean that shares have become some of the most attractive income-bearing investments available.

To gauge the affordability of a share for my income portfolio, I like to look at three key trailing yield figures — the dividend and earnings yields, and the return on equity. I call this my triple yield test:

Legal & General Value
Current share price 222p
Dividend yield 3.6%
Earnings yield 6.5%
Return on equity 16.2%
FTSE 100 average dividend yield 2.9%
FTSE 100 earnings yield 5.8%
Instant access cash savings rate 1.5%
UK 10yr govt bond yield 2.7%

A share’s earnings yield is simply the inverse of its P/E ratio, and makes it easier to compare a company’s earnings with its dividend yield. Legal & General’s earnings yield of 6.5% equates to a trailing P/E ratio of 15.4, slightly cheaper than the FTSE 100 average of 17.2.

Legal & General’s return on equity of 16.2% indicates strong profitability, and although the firm’s 3.6% dividend yield is already comfortably above the FTSE average of 2.9%, Legal & General shareholders may be about to receive a generous pay rise: the company’s interim payout rose by 22% this year, and analysts’ forecasts suggest that the firm’s final dividend will rise by a similar amount, giving a prospective yield of 4.2%.

Is Legal & General a buy?

Like many financial stocks, Legal & General was forced to cut its dividend in 2008 and 2009, but the dividend was never cancelled, and even including the cuts, Legal & General’s dividend has risen by an average of 5.1% per year since 2007.

Legal & General’s earnings are expected to have risen by 15% in 2013, but earnings growth is expected to halve to around 8% in 2014. It’s worth remembering that Legal & General shares are currently trading within 10p of their all-time high, and don’t look especially cheap on a prospective P/E of 14.2.

I believe there may be better buying opportunities later this year, so rate the shares as a hold.

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> Roland does not own shares in Legal & General.