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For investors who own Legal & General (LSE:LGEN) shares, the prospect of dividend income is a big part of the attraction. In fact, it’s been the only attraction over the last few years.
The share price has climbed by an average of 2.3% a year over the last five years. But with a current dividend yield of 8.5%, investors might think this doesn’t matter.
Dividend income
Over the last 12 months, the FTSE 100 firm’s returned 21.36p to shareholders as dividends. That means generating £1,000 a year would involve buying 4,682 shares. At today’s prices, an investment at that scale requires £11,995. On the face of it, that’s not actually too bad – there aren’t many other stocks offering that kind of cash return right now.
A high dividend yield can often be a sign that investors see a business as risky. And with Legal & General, there’s a clear reason to be wary that it’s important to take note of. In 2024, the company generated 20.23 in core earnings per share. That’s below the 21.36p it distributed in dividends, meaning the firm sent out more cash than it took in.
Surplus cash
Obviously, no company can do this indefinitely, but I don’t expect Legal & General to be forced to cut its dividend any time soon. There are a few reasons for this. One is that the firm has stated its intention to increase its dividend by 2% a year until 2027. That’s a sign the company thinks it has a clear path towards doing this.
Another is Legal & General’s huge cash reserves. The business has to maintain certain capital levels to meet its Solvency II requirements, but it currently has £9.4bn in excess cash beyond this. By itself, that covers the £1.2bn in annual dividends several times over. And while the firm can’t just return this to investors, it might be able to use it to support its projected dividend growth.
Earning £1,000
If Legal & General’s dividend increases in line with its current expectations, the number of shares investors need to earn £1,000 a year is set to come down. By 2027, 4,497 shares could be enough.
Of course, it’s no coincidence that the stock’s gone up as the dividend increased. So I don’t think there’s much of an advantage to be had by waiting around.
The biggest risk with the company remains the long duration of Legal & General’s policies. With annuities contracts in particular, the effects of mispricing a risk can last for decades.
That’s something investors need to take seriously when looking at the stock and its 8.5% dividend yield. But if things go well, it could be a terrific source of passive income for a long time.
An unusual opportunity
Back in 2021, Legal & General shares came with a dividend yield of 6.2%. At that level, earning £1,000 a year in dividends would have taken a £16,129 investment.
The same return at today’s prices is available for £11,995. And it’s not as though investors buying the stock today get an inferior product – it’s the same company.
Given this, I think the stock has to be worth considering for passive income investors. Especially with the potential to fill in short-term weakness in earnings with the firm’s excess cash reserves.
