Is the 8.8% Legal & General dividend yield a golden opportunity or a red flag?

I like the passive income prospects of a high dividend yield from a quality company. I regard FTSE 100 financial services Legal & General (LSE: LGEN) as a quality company. It has been around for centuries, has a large customer base, and a proven business model. The Legal & General dividend is also something I like a lot. Its 8.8% yield puts the company among the most generous of dividend payers in the blue-chip index.

However, a high yield can be a red flag that the City expects a dividend cut may happen in future and is pricing the share accordingly. The 8.8% Legal & General dividend yield is well over twice the index’s average, which currently stands at 3.5%.

Legal & General has grown its dividend annually in recent years and plans to keep doing so. But it has set out an expectation of lower annual growth in the dividend per share (2% instead of 5%) from this year onwards. What does that mean for me as a shareholder?

I’m planning to hold

The answer may turn out to be: not much.

I plan to hang onto my Legal & General shares as I reckon the dividend yield remains highly attractive. While a slower growth rate is not brilliant news, the yield is already well above average and even low single-digit percentage growth in the dividend per share could make it more attractive still.

The company feels flush enough with cash to be buying back its own shares on a regular basis. Indeed, this month the firm announced plans to spend half a billion pounds buying back its own shares.

Its core operating profit grew last year. But the profit before tax using IFRS accounting standards was more modest, at £542m versus £1.6bn for the core operating profit. Accounting in financial services can be devilishly complicated. That can make it hard for investors to get a very clear picture of how a company is performing at a granular level.

But, while earnings have fallen, Legal & General continues to be profitable and has a proven ability to generate large sums of excess cash. That matters because it is such free cash flows that enable a company to fund its dividends.

Keeping realistic expectations

But while the juicy Legal & General dividend continues to attract me, I also need to keep my enthusiasm grounded in reality.

The share price has soared 51% in five years.

That sounds great but it primarily reflects a slump during the pandemic. Over the past year, the share has dropped 4%.

As the company reduces in size due to asset sales, I think its share price could struggle to move up much, though the plan to buy back its own shares could help in that regard.

The lower dividend growth rate, while still in positive territory, could also be a sign that the company sees potentially lower future business growth prospects than before.

So, I am excited about the dividend potential of my Legal & General shareholding, but am keeping my expectations modest when it comes to share price performance.

The post Is the 8.8% Legal & General dividend yield a golden opportunity or a red flag? appeared first on The Motley Fool UK.

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C Ruane 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.