9% dividend yield! But this ‘Big Short’ investor is steering clear of Legal & General shares
Legal & General (LSE:LGEN) shares often come with a high dividend yield. This might be a huge passive income opportunity, or it could be a sign thereâs something to be concerned about.
Anyone thinking of buying the FTSE 100 stock should try to work out what it is thatâs putting investors off. And Steve Eisman â of the Big Short fame â has one possible answer.
Accounting
Eisman is famous for shorting the US housing market before the 2007-08 crash. And this wasnât luck â his big insight came from understanding the way mortgages were being accounted for.
This is connected to why Eisman stays well away from life insurance stocks, such as Legal & General. Itâs not that their accounting is misleading, itâs that itâs extremely difficult to evaluate.
One a recent episode of the Real Eisman Playbook, Eisman said the following in response to a question about Legal & General: âI spent an entire year learning about life insurance accounting. And frankly, it was brutal. And you know what? I think itâs a waste of your time. Itâs why life insurance stocks sell at ridiculously low multiples … I wouldnât waste my time.â
In general, I think staying within what Warren Buffett calls a “circle of competence” is a pretty good principle. And that might simply not include Legal & General.
The fact that even Steve Eisman can’t make sense of life insurance companies and their balance sheets makes me doubtful about my own prospects. So I’m minded to look elsewhere for stocks to buy.
Life insurance
Legal & General has recently been very active in the bulk annuities market. This is where the firm takes on some part of another companyâs future pension liabilities, in exchange for a fee.
The FTSE 100 company then invests the cash it receives to generate a return thatâs higher than the amount it ultimately has to pay out. And this is where the profit comes from on these deals.
There is, however, a lot to think about and potential risks are everywhere. One example is the prospect of falling interest rates causing the value of long-term liabilities to increase.
Lower interest rates also reduce the return the firm can generate by reinvesting older assets as they mature. And different bonds donât always respond in the same way.
The company makes various moves to try and offset this. These include investing in assets with similar durations, buying interest rate swaps, and passing on excess risk to reinsurers.
Is that effective? Answering that question confidently involves understanding the accounting that goes on inside the company â and not even Steve Eisman claims to be able to do that.
Risks and rewards
Legal & General is clearly an unusually complicated business. The question for investors is whether a 9% dividend yield is enough to offset this.
Steve Eisman’s view is that it clearly isn’t and I take the same view with my own portfolio. Different investors, however, might have different risk tolerances.
I don’t think it’s completely out of the question for someone to see the equation differently and accept the uncertainty in exchange for a 9% dividend yield. But it’s not one for me.
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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.
