Legal & General has had a volatile start to this year by its own standards. In the last month alone, the stock has fallen 17%, before quickly rebounding nearly 14% off the lows.
Despite rallying substantially in March and April, I think Legal & General is underappreciated by the market, and with a current dividend yield of 7.74%, I’m buying more.
So, what exactly happened to Legal & General, and why do I think it has the potential to rise from here? This article will dive into the company in more detail.
For those of you who aren’t aware, Legal & General is a UK-based financial services provider, with company segments including retirement, investment management, and insurance.
Due to the nature of its business, the company generates a steady cash flow, and returns a large portion of capital to shareholders in the form of dividends, making the stock one of the best income sources on the FTSE100. You’ll find it in the top 10 holdings of many UK income funds for this reason.
Dividend History
L&G has a strong track record of dividend payments. With a shaky few years leading up to the great financial crisis and a cut in 2011, the stock has massively increased dividends steadily from 2012 onwards.
What was an annual pay-out of 7.65 pence per share in 2012 has now grown to 19.37 pence per share in 2022, representing an impressive 253% dividend grown over 10 years.
Current Performance
What I’m more impressed about is its recent performance amid a challenging macroeconomic environment. In March of this year, L&G lifted its dividend 5% as it posted a jump on full-year operating profit of 12% to £2.52 billion pounds, beating consensus estimates of £2.46 billion pounds.
Chief Executive, Nigel Wilson put this down to the diversified nature of the business:
“Highly synergistic business model continuing to deliver significant benefits. Our balance sheet is strong and highly resilient, with a record solvency ratio of 236%”
Earnings per share increased to 38.33 pence per share, giving the company achieved a dividend cover of 1.98, so despite raising the dividend yet again, the pay-out remains well within the company’s ability to pay without the use of debt.
In fact, Legal & General has actually emerged stronger than it used to be pre 2020. The full year 2022 dividend is higher than it has been over the past 5 years from an absolute and percentage standpoint, while also remaining the lowest proportion of earnings per share, meaning that if there was ever an opportune time to invest in the stock for dividend safety, it’s today.
Now you would think that given such a strong full year performance, robust balance sheet, and dividend yield vastly outperforming the index that Legal & General would be trading at a premium. Well, you’d be wrong.
At today’s price of 250 pence per share, the stock is only trading at 6.5x times earnings. This is well below both the FTSE 100 market average of 12.4x times and even the wider financial sector of 9.5x times earnings, making it relatively attractive from a valuation standpoint.
Comparing it to the S&P current price to earnings ratio of 18.5x times, this highlights the stark contrast in investor confidence between the two countries, with many betting that the UK will continue to witness a low growth, low productivity environment.
And while that may be true, L&G has been able to largely sidestep a weak macroeconomic environment and continue to generate impressive results. So has the market mispriced Legal & General? I think so, but why?
Why is L&G undervalued?
I think it is 2-fold. Firstly, due to the weak outlook for the UK market as discussed earlier, and secondly due to the overspill of the recent banking turmoil. As Silicon Valley Bank collapsed in March, there was indiscriminate selling of any company globally within the financial services industry, irrespective of whether they could be affected in any similar way.
Investors irrationally rushed to exit their positions and Legal & General was caught up in the midst of all of this.
The stock fell 17% in March to a low of 220 pence per share, nearly falling to its 52-week lows seen during the LDI crisis in the UK, despite feeling the reverberations of what has now known to become an idiosyncratic risk more than anything systemic.
What I think was more worrying for the stock was the fall of Credit Suisse. Investors were worried that asset holders such as Legal & General could be exposed to counterparty risk if Credit Suisse went bankrupt.
There was a broad selloff in Europe that targeted the likes of Deutsche Bank, SocGen and BNP Paribas to name a few, which dragged the overall sector down, and despite this risk subsiding amid the forced acquisition of Credit Suisse by UBS, Legal & General is still yet to return to the price it was trading at before fear gripped the markets.
Given the low valuation relative to the sector and FTSE index, strong performance of full year earnings and favourable investor capital return program, I think Legal & General should be trading above 3 pounds per share.
A consistent 7.74% dividend yield is rarely seen, and an opportunity that I think should not be missed.
If you’re interested in more dividend stocks on the FTSE 100, I have included my top 5 in a recent article, which also includes Legal & General.
All in all, I think Legal & General is a well-diversified business run by an excellent management team, and a fantastic stock for passive income. Let me know in the comments below, do you hold Legal & General in your portfolio, or are considering to in the future?
