Legal & General Shares Drop to 243p: Is the 9% Yield Enticing?

Legal & General (LSE: LGEN) has experienced a notable decline in its share price, dropping from 266p to 243p in recent weeks. This downturn has resulted in the company’s shares sporting a dividend yield of approximately 9%. Given this considerable yield, investors may wonder whether now is the right time to consider purchasing shares in this established insurer.

Understanding the Massive Yield

A dividend yield of 9% naturally attracts attention, but investors should be cautious. In finance, high yields often come with significant risks. Currently, Legal & General’s dividend coverage, which measures the ratio of earnings per share to dividends per share, is projected to be below one for the year. Such a low ratio raises concerns about the sustainability of dividend payments.

A dividend cut could lead to not only disappointing income for investors but also a decline in share prices. This dual risk emphasizes the importance of examining the underlying factors contributing to the high yield.

Identifying the Risks

Several issues warrant consideration before investing in Legal & General shares. Firstly, the company’s low dividend coverage is a crucial red flag. A ratio under one indicates that earnings may not sufficiently cover dividend payments, putting future payouts in jeopardy.

Secondly, the recent volatility in the UK gilt market has raised eyebrows among institutional investors. Last week, long-term UK borrowing costs reached their highest levels since 1998, impacting the company’s share price. Legal & General is a significant player in the liability-driven investment (LDI) sector, which involves generating returns from assets to meet future liabilities, such as those from pension schemes. Increased volatility in the gilt market poses challenges for LDI investors, especially those holding gilt derivatives. Margin calls on these positions can lead to liquidity issues, balance sheet strain, and potentially impact dividend distributions, which could further affect share prices.

Despite these challenges, some analysts suggest that Legal & General may still be worth considering. The company has several growth drivers, including rising equity markets that benefit its investment management division, a growing pension risk transfer (PRT) sector, and an expansion into alternative investments. Share buybacks could also contribute to increasing earnings per share.

However, potential investors should remain aware of the balance sheet risks associated with the company. Recent market movements indicate that institutional investors are approaching the stock with caution, reflecting broader concerns about the company’s financial outlook.

In conclusion, while the 9% dividend yield may be appealing, investors should carefully weigh the risks associated with Legal & General before making any decisions. A thorough analysis of the company’s financial health and market conditions is essential for anyone considering an investment at this time.