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Legal & General (LSE: LGEN) has long been a favourite of investors seeking a second income. The insurance and asset management group is often considered the bellwether of UK dividend stocks – and with good reason.
Right now, the shares are trading at around £2.34 each with a dividend yield of 9.2%. On paper, that looks very tempting. An investor with 10,000 shares — costing £23,400 at current prices — would be in line to collect about £2,145 in dividends every year.
Sure, that’s a decent bit of income – but it’s a lot of cash to invest in one go. Fortunately, the miracle of compounding returns could do the heavy lifting over time. For instance, if the current yield held, an investor contributing £100 a month and reinvesting the dividends could potentially grow that pot to £22,330 over a decade.
Not bad – but a lot can happen in 10 years, so it’s important to carefully assess every investment.
Why Legal & General?
Just because Legal & General’s been a favourite for years does not mean it remains the best option today. The shares have dropped 10% in the past month alone. Earnings have fallen significantly too, down 31.8% year on year.
This hasn’t gone unnoticed by analysts. This week, AlphaValue shifted its rating on the stock from Add to Reduce. Both UBS and JPMorgan also cut their views last month to Neutral. That paints a picture of cooling sentiment.
Valuation metrics suggest a premium price tag as well. The company trades on a price-to-earnings (P/E) ratio of 63.2 — far higher than most of its peers. That seems difficult to justify given the recent decline in profitability.
Still a dividend powerhouse?
One reason investors continue to consider Legal & General is its outstanding dividend track record. Apart from one major cut during the 2008 financial crisis and a temporary pause in the pandemic, the payouts have held up remarkably well.
Over the past 15 years, dividends have grown at a compound annual rate of 11.8%. More recently, the company also completed a £500m share buyback programme on 3 September. Moves like this should, in theory, reward long-term shareholders – and there’s a strong possibility they will.
The problem is that the earnings decline makes the dividend look less secure. The coverage ratio’s thin, which raises the risk of another pause or even a reduction. For a business so closely tied to the second income story, that’s a real concern.
My verdict
A year ago, it would have seemed unlikely that Legal & General would end up in this situation. Yet here we are — falling earnings, a stretched valuation and increasing broker scepticism.
For investors chasing a second income, I think the stock’s looking less attractive. There are other UK companies offering solid dividends with stronger coverage ratios. Yes, it might still recover but, at this stage, it’s difficult to see much light at the end of the tunnel.
As a long-term shareholder, I sincerely hope the business gets back on track. But right now, I don’t think it’s one to consider.
