When it comes to FTSE 100 income shares, it is hard to beat M&G (LSE: MNG) for yield. At the moment, the M&G dividend yield of 9.8% means it is among the most lucrative shares in the blue-chip index.
Not only that, the but the share price looks cheap to me too.
Currently, M&G shares trade on a price-to-earnings ratio of 28. Admittedly, that might not seem much of a bargain. But stepping aside from earnings and looking at the company’s cash flow generation prospects, I think its £4.8bn market capitalisation is low.
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After all, in recent years the company has paid out hundreds of millions of pounds in dividends annually as well as spending money buying back shares several years ago. I think its proven business model could continue to generate significant excess cash.
That could hopefully support the dividend. M&G’s stated dividend policy is to maintain or increase its dividend per share annually, although whether it is able to keep doing that in practice will ultimately boil down to its business performance.
Looking at a high yield from a critical perspective
Now, while I see the 9.8% yield as something to like, a high yield (well over double the FTSE 100 average in this case) can also be a warning signal that the City has concerns about the sustainability of a dividend.
In M&G’s case, I see a few risks. One is that policyholders may pull more funds out of the asset manager than they put into it. Excluding its Heritage business, that was the case in the first half of the year.
Another risk I see is that a general economic slowdown could hurt asset managers more broadly, including M&G. In fact I think concerns like that help to explain why M&G, despite its great dividend, continues to trade at what I see as a cheap price. In fact, the shares are 10% cheaper now than they were five years ago.
Why I’m holding
I have no plans to sell my M&G shares. At the current price, I think that M&G is a dividend share investors should consider.
It has proved it knows how to generate large sums of excess cash. That is not a coincidence, but reflects the strategic choices the company has made over time. It operates in a field that benefits from high long-term customer demand. Within that space, it has deep expertise, a well-known brand and also a customer base in the millions.
All of that helps M&G to generate cash. Cash generation and earnings are not the same thing. Earnings are an accounting concept and for an asset manager like M&G they can reflect short-term changes in asset values. So I prefer to look at whether such a firm can generate lots of excess cash in future.
In the case of dividend machine M&G, I think the answer is yes.
