A high dividend yield can be great for investors looking for passive income. But it can also be a sign that the stock market thinks the underlying business isn’t going to be able to maintain its distributions for long.
Legal & General (LSE:LGEN) shares currently come with a 9% dividend. But with the average total return from the FTSE 100 over the last five years around 3.77%, is this a once-in-a-lifetime opportunity or a trap?
History
Legal & General isn’t the only FTSE 100 stock to offer a big dividend – British American Tobacco shares have a similar yield. But unlike the tobacco company, I don’t think LGEN’s business is in terminal decline.
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Over the last five years, the company has had a pretty good record when it comes to shareholder distributions. Since 2018, each year’s dividend has been higher than the preceding one.
In 2021, the difference was pretty marginal – 17.82p up from 17.57p. But I’d argue that this is a responsible move from management at a time when the business was facing an uncertain time.
On average, the dividend per share has increased by around 4.5% annually since 2018. That’s not spectacular, but a stock with a 9% yield doesn’t need huge growth to be a good investment.
Total return
Since 2018, the Legal & General share price has fallen by just over 8%. So if I had invested £1,000 in the stock five years ago, my stake today would have a market value of £918.
I’d also have received £377 in dividends, though. Adding those in means my total shareholder return would have been £1,295 – an annual return of 5.3%.
This is still a pretty good return. And it’s clearly better than the 3.77% a year the FTSE 100 has returned over the last five years.
In my view, though, this is the thing that investors need to keep their eye on with Legal & General shares. If the share price falls, the total return might be less than the eye-catching dividend yield.
Building wealth vs earning passive income
How much of a problem is this? In my view, it depends on whether someone is looking to own the stock as a source of passive income, or to build wealth.
For someone who wants to keep the stock and collect dividends, this arguably isn’t an issue. As long as the company keeps generating enough cash to maintain its distributions, an income investor should do fine.
A dividend investor who has no intention of selling the stock probably shouldn’t worry about what happens to the price. Things are different for someone looking to build wealth, though.
If the stock goes down, this will weigh on the extent to which it contributes to someone’s net worth. As such the likely direction of the company’s share price is something that growth investors should pay attention to.
Legal & General shares
To me, Legal & General shares look like a classic passive income stock. The company has a great record when it comes to dividends and I think the outlook on this front is good.
A falling share price goes some way towards offsetting the high dividend yield, though. As a result, I don’t see this as such an obvious buy for investors looking to build wealth.
