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FTSE 100 financial services giant Legal & General (LSE: LGEN) paid a dividend last year of 21.36p. On the current share price of £2.49, this gives a spectacular yield of 8.6%.
By comparison, the average FTSE 100 yield is currently 3.5%. And the ‘risk-free rate’ — the 10-year UK government bond yield — is 4.5%.
Since 2020’s dividend of 17.57p, Legal & General has raised this annual payment by 22%.
Looking ahead, consensus analysts’ estimates are that it will increase it to 21.8p for 2025, 22.3p for 2026, and 22.6p for 2027. Based on the current share price, this would generate respective yields of 8.8%, 9%, and 9.1%.
How much dividend income could it make?
Investors considering a holding of £11,000 (the average UK savings) in the firm would make £946 in first-year dividends. Over 10 years on the same 8.6% average yield – no forecast increases accounted for – this would rise to £9,460. And over 30 years on the same basis this would jump to £28,380.
Crucially though, these returns could be turbocharged through the standard investment practice of ‘dividend compounding’. This simply involves reinvesting the dividends paid by a stock straight back into it. That is, until such time as an investor wants to draw them out to supplement their income or to retire.
Specifically in this instance, after 10 years’ compounding at an average 8.4% yield, the dividends would rise to £14,915, not £9,460. And after 30 years, the dividends would be £132,839 rather than £28,380.
As with leaving interest to accrue in a savings account, the effect of dividend compounding becomes more pronounced over time.
At the end of that 30-year period, the total value of the initial £11,000 holding in Legal & General would be £143,839. And this would generate an annual dividend income of £12,370!
A potential share price gain too?
Nobody would want to see such dividend gains reduced by losses on the firm’s share price. These would only be realised if an investor sold the stock, of course. But even in that event, far better to make a profit.
This is why I only ever buy stocks that look at least 30% undervalued to their price. These two things are different. Price is what the market is willing to pay for a share. Value is what a stock is fundamentally worth, based on the underlying business.
A risk to Legal & General’s share price is another surge in the cost of living. This could prompt clients to reduce the size of their accounts or to close them.
However, a discounted cash flow analysis shows the shares are a whopping 56% undervalued at their current £2.49 price. This modelling identifies where any firm’s share price should be, centred on cash flow forecasts for the business.
Therefore, their fair value is £5.66.
Will I buy more?
Powering any firm’s share price and dividends over time is its earnings growth. Consensus analysts’ forecasts are that Legal & General’s earnings will rise a spectacular 28% a year to the end of 2027.
Its ultra-high dividend yield and extremely undervalued price mean I will buy more of the stock very soon.
