Legal & General (LSE: LGEN) shares have long been a core holding in my high-yield portfolio. This has been constructed to pay me as much passive income as possible, so I can continue to cut down on my workload.
How much can I make?
In 2023, the firm increased its dividend by 5%, to 20.34p. On the current share price of £2.50, this gives a yield of 8.1%.
So £11,000 — the average savings amount in the UK — invested at 8.1% would make £891 this year in dividends payments.
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If the yield averaged the same over 10 years, the dividends would be £8,910 on top of the £11,000 investment.
Crucially however, these returns could be turbo-charged by reinvesting the dividends paid back into the stock. This is known as ‘dividend compounding’ and is the same process as compound interest in a bank account.
If this was done, then I would have an additional £13,660 instead of £8.910 after 10 years. This would mean £24,660 in total, paying £1,913 a year in dividends, or £159 a month.
Over 30 years on an average 8.1% yield, the investment pot would total £123,932, paying £9,612 a year, or £801 a month.
Achieving even more from £0
Surprisingly to many perhaps, the same can be achieved from a starting point of £0 in the bank.
Investing just £5 a day — £150 a month – in 8.1%-yielding Legal & General shares would produce £27,782 after 10 years. This is also provided that the dividends are reinvested back into the stock.
After 30 years on the same basis, the total would be £229,685. This would pay £17,748 a year, or £1,479 every month in dividend payments.
Can these high returns be sustained?
Growth in earnings and profits drives increases in a company’s share price and its dividends over time.
One risk in the company is that its 3.8 debt-to-equity ratio is higher than the 2.5 or so considered healthy for investment firms. Another is a new global financial crisis.
However, Legal & General made an operating profit last year of £1.67bn, against 2022’s £1.66bn. It has forecast cumulative Solvency II capital generation of £8bn-£9bn by the end of this year. These are strong capital buffers for the future.
Consensus analysts’ expectations are now for its earnings to grow by 22.9% a year to the end of 2026.
Do the shares look undervalued?
The company currently trades at 3.1 on the key price-to-book (P/B) measurement of stock value. This compares to a peer group average of 3.5, so it is cheap on that basis.
It also looks cheap at its price-to-sales (P/S) ratio of just 1.2, against a competitor average of 1.6.
But how cheap exactly? A discounted cash flow analysis using several analysts’ figures and my own reveals it to be around 58% undervalued at the current price of £2.50.
Therefore, a fair value would be around £5.95, although this does not guarantee it will ever reach that price.
However, being so undervalued does reduce the chance of a sustained major share price fall wiping out my dividend gains.
Given their high yield, apparent undervaluation, and growth prospects, I am looking to buy more Legal & General shares shortly.
