Choosing shares that generate high passive income from dividends is more important to me now than ever.
Many investment opportunities in high-yield, high-quality assets have opened up as global interest rates have risen, notably in the bond market.
So, my view is that a FTSE 100 company needs to make it worth my while to become a stakeholder in their business. This is effectively what stock investors are.
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In addition to a high yield, I also look at the core business, and its share valuation compared to its peers. After all, I do not want my high-yield returns wiped out by future share price losses.
Legal & General (LSE: LGEN) ticks these three boxes for me.
Fears of a new financial crisis remain a risk for the shares, of course. Another is that inflation and interest rates remain high, acting as a deterrent to new-client business.
Undervalued to peers
Firstly, it looks extremely undervalued to me compared to its peers.
On a price-to-earnings (P/E) ratio basis, it is currently trading at 6.4. Prudential is at 8.7, Hansard Global at 11.1, Admiral at 19.7, and Beazley at 28.2. This gives a peer group average of 16.9.
To gauge the level of undervaluation, I use a discounted cash flow (DCF) methodology. Given the assumptions involved in this, I use several analysts’ DCF valuations as well as my figures.
The core assessments for Legal & General are between 53% and 58% undervalued. Taking the lowest of these would give a fair value per share of £4.63.
This does not mean that the stock will reach that point, of course. However, it underlines that the shares currently offer excellent value.
Core business positioned for growth
Secondly, Legal & General’s core business looks poised for growth to me. Its retirement solutions operation remains a market leader in the UK Pension Risk Transfer (PRT) space. This is where a company takes over other companies’ pension scheme commitments for a guaranteed return from them.
It is also in the Top 10 in the US PRT market, which has exceptional growth potential. Only around 9% of the US’s $3trn of defined benefit pension schemes have been transferred so far.
Legal & General Investment Management is also a leading global asset manager. It is ranked 11th in the world, with £1.2trn of assets under management.
Big passive income generator
And last year saw Legal & General paying out a total of 19.37p per share. Based on the current share price of £2.18, this gives a yield of 8.9%.
This year’s interim dividend was 5.71p, compared to last year’s 5.44p. That suggests to me that this year’s total dividend may also be higher than last year’s.
Even if the yield remains the same, a £10,000 investment would make £890 this year. Over 10 years, if the rate remained the same, it would total £8,900 to add to the initial £10,000 investment. This is over and above share price gains or losses and tax obligations incurred, of course.
I already hold shares in the company, but if I did not I would buy the stock now. I think it should eventually recoup all this year’s 19% loss, although I don’t know when. I also think it will gradually converge towards its fair value over time, in addition to paying excellent dividends.
