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Legal & General (LSE: LGEN) shares have been a key holding in my passive income portfolio for years.
These stocks were chosen to give me a high level of income from dividends so I can reduce my working commitments. This is done with minimal daily effort from me – hence the ‘passive’ element relating to these holdings.
Last year, the financial services giant paid out 20.34p a share, which yields 8.5% on the current £2.40 stock price.
So, an investor considering a stake of £11,000 (the average UK savings) in the firm would make £935 in dividends this year. This would rise to £9,350 over 10 years on the same average yield. And after 30 years on the same basis, the dividends paid would reach £28,050.
The power of dividend compounding
This return is much more than can be had from a standard UK savings amount. But it could be vastly greater if the common investment practice of ‘dividend compounding’ was used.
This simply involves reinvesting the dividends paid by a stock straight back into it.
Doing this on the same average 8.5% yield (which is not guaranteed) would generate £14,659 in dividends after 10 years, not £9,350. And it would increase to £128,617 after 30 years, rather than £28,050.
Including the £11,000 stake, the holding would be worth £139,617 by then. This would pay £11,867 a year in passive income.
Yield forecast to rise
A stock’s yield changes as its price and annual dividend alter.
In Legal & General’s case, analysts forecast that it will increase its dividend to 21.8p in 2025, 22.3p in 2026, and 22.6p in 2026.
This would give respective yields on the current share price of 9.1%, 9.3% and 9.4%.
A risk here is the intense competition in the sector that may squeeze its profit margins.
However, analysts forecast that its earnings will rise 25.1% each year to end-2027.
And it is growth in these that ultimately powers a firm’s dividend – and share price – higher.
Are the shares undervalued right now?
My favoured method to get to the bottom of a stock’s valuation is the discounted cash flow (DCF) method.
This evaluates where any share price should be, based on future cash flow forecasts for a firm.
The DCF for Legal & General shows it is 21% undervalued now. So the fair value for the stock is technically £3, although the market may push it lower (or higher).
What’s the new deal?
Japanese insurer Meiji Yasuda will purchase Legal & General’s US protection business and become a strategic partner in its US Pension Risk Transfer (PRT) business.
The PRT market involves a company being paid by other firms to take over the running of their pension schemes. Legal & General is already a top 10 provider for this in the US. And there is enormous potential there, as around $3trn of defined benefit pension schemes have yet to be transferred.
Of the sale’s $2.3bn (£1.8bn) proceeds, Legal & General will use £400m to fund its US PRT expansion. And £1bn will be returned to shareholders in a buyback, which tends to support share price gains. The remainder will go into bolstering its already-healthy Solvency II ratio.
Given this deal and earnings growth forecasts that should push its share price and dividend higher, I will be buying more of the shares very soon.
