The UK financial services sector certainly has some juicy dividend yields right now. Insurer Aviva (LSE: AV) yields 7.2%, for example. That attracts me and I would happily buy Aviva shares for my portfolio if I had spare cash to invest. But even better than the Aviva dividend yield is that offered by Legal & General (LSE: LGEN), currently standing at 8.6%.
I would also happily buy Legal & General shares if I had the spare cash. Looking at the two shares from an income perspective though, which looks more immediately appealing to me?
The long-term demand picture is strong
I would begin by considering what long-term customer demand is likely to be for the areas in which the companies operate.
In both cases I am upbeat about that when it comes to these financial services firms. Whether it is insurance for Aviva or the wider range of services offered by Legal & General, I expect demand to stay high even in a tough economy.
Market niche as the foundation for profitability
But markets with high, resilient demand can attract a lot of competitors. That can potentially push down pricing levels and so hurt profit margins.
So it helps – some investors would even consider it essential – for a company to offer something that can attract customers.
Both Aviva and Legal & General meet this test, in my view.
Strong brands, large customer bases and deep experience in their respective markets are all factors going in their favour when it comes to making profits.
Last year, Aviva made a £1.1bn profit after tax and Legal & General £443m.
Funding future dividends
Profit does not tell the whole story, however.
Swings in the value of assets that financial services companies hold can mean that the accounting concept of reported earnings do not properly reflect the cash generated. For the Legal & General or Aviva dividend to survive, each firm ultimately needs to generate enough cash to support it.
A cut is a real risk, as with any share. Aviva reduced its dividend in 2020, while Legal & General did the same during the 2008 financial crisis.
I see a risk that the same could happen again at either firm, for example if rocky financial markets hurt returns.
For now, though, growth is the name of the game. Both the Aviva dividend and its Legal & General counterpart grew last year, by 7.7% and 5%, respectively.
Where things go from here
With strong cash flows I think both businesses could continue to raise their dividends in future.
Both are proven cash generators and have space to increase their payout if they can maintain their recent levels of cash generation.
If I had spare cash to invest, I would happily buy both. But my first purchase of the two would be Legal & General. An 8.6% dividend yield from a proven FTSE 100 company is very attractive to me.
