Does a 9.3% yield and a growing dividend make Legal & General shares a passive income no-brainer?

Legal & General (LSE:LGEN) shares currently come with a dividend yield of 9.3%. That’s higher than the FTSE 100 average, well above inflation, and a lot better than the interest available on cash.

That makes it look as though investors looking for passive income should be piling into the stock. If only it were that easy – the reality is (unfortunately) a bit more complicated.

Five-year returns

Five years ago, Legal & General was trading with a 6.6% dividend yield. Things were different back then, but this was still an eye-catching return.

Since then, the company has grown its shareholder distributions each year. The average annual increase has been only around 3%, but it’s been impressively consistent.

Legal & General dividends per share 2020-24

Created at TradingView

The trouble is, this hasn’t translated into a great result for shareholders. While it has paid out a total of 94.37p per share, this has mostly been offset by the stock falling 82.44p in that time.

As a result, investors who bought the stock in December 2020 are 3.9% in total on their investment. That’s lower than the FTSE 100, well below inflation, and even worse than the return available on cash.

Is the dividend safe?

A 9.3% dividend offers a lot more protection from a falling share price than a 6.6% one. And the yield hasn’t been at this level at any point in the last 10 years.

Legal & General dividend yield 2015-24

Created at TradingView

Management is forecasting a 2% annual increase in the dividend with additional cash to be distributed through share buybacks. But investors might initially wonder how Legal & General is going to fund this.

The firm currently pays out more to shareholders than it brings in as net income. But while this might look like a source of concern, it’s probably less of a risk than it initially appears.

Legal & General dividends per share vs. earnings per share 2020-24

Created at TradingView

At the end of 2023, Legal & General has more than £9bn of excess capital after meeting its Solvency Capital Requirement. This should mean the company is able to meet its ongoing dividend commitments.

Outlook

In terms of future growth, Legal & General’s main engine is its Pensions Risk Transfer business. It takes on future guaranteed pension obligations from other companies – in exchange for a fee.

Management is optimistic about the pipeline for new deals over the next few years. But investors need to be clear that the quality is there as well as the quantity.

Getting cash up front before paying out costs later is a nice structure. But the deals have an asymmetric risk structure – the amount Legal & General can make is fixed while the potential liabilities are not.

Even including the returns the firm can generate by investing the premiums, it will be a long time until the profitability of the contracts becomes clear. And this is where the risk comes from for investors.

A no-brainer?

As an investment, Legal & General shares are anything but a no-brainer. The nature of the firm’s potential liabilities means there’s a lot of uncertainty about the future, especially over the long term.

That’s why the dividend yield is so high – investors need something to give them a margin of safety against the ongoing risks. While 9.3% might be enough for some, I’m looking elsewhere.

The post Does a 9.3% yield and a growing dividend make Legal & General shares a passive income no-brainer? appeared first on The Motley Fool UK.

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Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.