One of the earliest stocks I ever bought was FTSE 100 insurer and asset manager Legal & General (LSE: LGEN). That, and a now-defunct oil company.
I was in my late teens and didn’t really know what I was doing at the time. But I liked the idea of making money from something at which I didn’t have to work too hard every day. I later found out this was called investing for passive income.
I also found out that only Legal & General would pay me something just for holding its shares — dividends.
The other one would only benefit me if its share price increased and I sold the stock. As it went bust anyway, it saved me the trouble!
Since then, I have always favoured buying stocks that pay me a dividend. And Legal & General is still in my portfolio to this day.
Passive income star
Currently, it pays a dividend that gives me an 8.2% return on my money. So, if I was starting out again now, with say, £10,000, that would make me another £820 this year.
If, as when I was younger, I withdrew this dividend every year, I would make £8,200 after 10 years. That’s providing this 8.2% yield stayed the same (but it actually goes up and down with dividend payouts and share prices).
What I found out – thankfully, early on — was how much more I could make if I reinvested the dividends back into the stock.
By ‘dividend compounding’ after 10 years at an 8.2% yield, I would have £22,642 instead. This would pay me £1,777 of passive income each year, or £148 every month.
After 30 years of doing this, I would have £116,073, paying me £9,108 a year, or £759 each month!
Can the dividends be sustained?
For this to work over a long period though, a company needs to generate sufficient income to pay the dividends.
In this respect, Legal & General has always looked solid enough to me, and it still does. It made an operating profit in 2023 of £1.67bn, against 2022’s £1.66bn.
Admittedly, its debt-to-equity ratio of 3.8 is higher than the 2.5 or so considered healthy for insurance and investment firms. So I’d like to see this trending lower over the next three years.
But any risk is mitigated for me by its short-term assets (£79.6bn) exceeding its short-term liabilities (£72.2bn).
It has also forecast cumulative Solvency II capital generation of £8bn-£9bn by the end of this year.
These strong capital buffers would also help to mitigate the effects of any future wider financial crisis, in my view.
The shares look like a bargain
Another positive for me is that Legal & General shares look cheap to me against their peers. This reduces the chances of these big dividend payouts being wiped out by large share price losses.
A discounted cash flow analysis reveals that the stock is around 58% undervalued. So a fair value would be around £5.93 a share, against the current £2.49.
This does not necessarily mean it will ever reach that price, of course. But it does indicate to me that it is very good value as well as paying very high dividends.
This post was originally published on Motley Fool
