At first glance, Legal & General (LSE: LGEN) shares look like an open-and-shut buy-and-hold case for me.
This is a solid FTSE 100 blue-chip that offers a magnificent trailing yield of 8.85%, smashing the returns on cash. The only possible verdict is Buy then hang on for the long term, surely?
But it’s more complicated than that. With a big stake in Legal & General, even I’m not totally persuaded.
That sky-high dividend is a thing of beauty, and incredibly, the yield is forecast to climb to 9.5% this year. But it also has a dark side.
Will it ever grow?
It has wafer-thin cover of just 1.1 times earnings, which gives pause for thought. Can Legal & General really afford its largesse?
The board reckons it can, but it’s also cautious. Last June, it announced new dividend guidance. After hiking the dividend by 5% in full-year 2024, it will increase at a slower 2% thereafter.
Legal & General has a heap of excess capital on top of its regulatory requirements, roughly £9bn at last count. The board also expects to generate another £5bn to £6bn of capital between now and 2027 and felt sufficiently confident to announce a £200m share buyback in June.
Yet that capital generation was slightly lower than hoped, and the share buyback wasn’t exactly dazzling.
The dividend has grown at an average pace of around 3% in recent years, so a drop to 2% is a disappointment. Although given the massive yield, it’s hard to complain. Let’s see what the chart says.
Chart by TradingView
Now let’s turn to the share price. Here, the news is poor. It fell 6.3% over the last 12 months, reducing the total return to around 2.5% after the dividend. Over five years, the stock is down 25%, wiping out most of the income. Saving cash would have done better.
The last five years have obviously been bumpy, as they saw the pandemic, the cost-of-living crisis and political turmoil.
The financials sector should get a lift when interest rates finally start falling. As the return from low-risk rivals like cash and bonds drops, ultra-high-yielders like this one will look more tempting.
I’m still hanging around for those dividends
Lower interest rates should also boost the stock market generally, potentially driving up the value of the £1.2trn of assets Legal & General manages. The downside is that this could hit sales of personal annuities, which have rebounded lately as rates rise.
Legal & General operates in a mature and competitive market, but it has one big opportunity: pension risk transfers, often called bulk annuities. This involves taking on responsibility for running companies’ final salary pension schemes.
The market is worth £6trn in the UK, yet so far only a small number of companies have transferred their schemes to insurers. Plus there’s a growing opportunity in the US, Canada, and the Netherlands.
This isn’t without risk. There’s a reason companies want to pass on their pension liabilities. Legal & General’s actuaries need to manage them carefully.
Yet the 16 analysts following the stock predict a solid one-year share price increase of 15%. Combined with the forecast yield it could deliver a 25% total return.
I’d be happy with that — no guarantees though. I’m hanging on to my Legal & General shares despite recent underwhelming performance. But I’m biting my nails.
This post was originally published on Motley Fool
