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Shares in Legal & General (LSE:LGEN) currently have a dividend yield of over 8%. By itself, that’s higher than the average annual return from the FTSE 100 over the last 20 years.
A high dividend yield is a sign shareholders are concerned about something. But the company has a strong record of returning cash to investors, so is the stock an outstanding opportunity?
Dividend coverage
On the face of it, there’s an obvious reason why Legal & General’s dividend should be considered risky. Over the last couple of years, the firm has paid out more than it has been making.
| Year | Earnings per share | Dividend per share |
|---|---|---|
| 2024 | 19.38p | 21.36p |
| 2023 | 7.35p | 20.34p |
| 2022 | 38.33p | 19.37p |
That’s not a particularly encouraging sign, but the dividend might not immediately be under threat. The company can maintain its distributions using the excess cash on its balance sheet.
At the end of 2024, Legal & General reported having a Solvency II coverage ratio of over 200%. In other words, it has over twice the capital it needs to comply with solvency requirements.
Releasing part of this is one way of maintaining its dividend even when earnings are unusually low in a particular year. And the company can actually do this for quite some time.
In total, the firm paid out just under £1.3bn in dividends in 2024. And its Solvency II excess is around £9bn, which means significant excess funds that can be used.
No company can pay out more than it makes indefinitely. But unless something changes, Legal & General should have a good amount of time until it gets into difficulties with its dividend.
Growth
Another reason stocks trade with high dividend yields is that investors sometimes worry about growth prospects. But Legal & General has done relatively well on this front recently.
A big part of this has been the bulk annuity (or pension risk transfer) deals the firm has done. These involve the company taking on future pension liabilities, in exchange for a fee.
The most prominent example – but there have been many more – is Boots. In 2023, the company paid Legal & General £4.8bn to take on the future obligations for its 53,000 members.
This has been an important growth engine for the firm recently. And demand in this area continues to grow, so there should be further opportunities on this front.
Insurance is an uncertain business – it involves receiving a specified amount of cash in exchange for an uncertain future liability. And the risks are especially great with things like annuities.
Unlike car insurance or health insurance, underwriting pensions involves policies that last for decades. So the consequences of misjudging the future payout can be enormous over time.
Dividend yield
This is why I think Legal & General shares routinely come with such high dividend yields. Writing long-term insurance policies is very risky and this is reflected in the share price.
Like the company itself, investors considering buying the stock need to make sure they’re adequately compensated for the risks they take on. And the dividend is a big part of this.
The company’s excess cash means the dividend should be sustainable even if earnings take a couple of years to catch up. Given this, I think the stock is worth considering for income investors.
