Dividend paying stocks like Legal & General Group Plc (LON:LGEN) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
In this case, Legal & General Group likely looks attractive to investors, given its 6.3% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. Some simple research can reduce the risk of buying Legal & General Group for its dividend - read on to learn more.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Looking at the data, we can see that 79% of Legal & General Group's profits were paid out as dividends in the last 12 months. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. Legal & General Group has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past 10-year period, the first annual payment was UK£0.05 in 2011, compared to UK£0.2 last year. This works out to be a compound annual growth rate (CAGR) of approximately 14% a year over that time.
It's rare to find a company that has grown its dividends rapidly over 10 years and not had any notable cuts, but Legal & General Group has done it, which we really like.
Dividend Growth Potential
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Earnings have grown at around 4.0% a year for the past five years, which is better than seeing them shrink! Earnings are not growing quickly at all, and the company is paying out most of its profit as dividends. When the rate of return on reinvestment opportunities falls below a certain minimum level, companies often elect to pay a larger dividend instead. This is why many mature companies often have larger dividend yields.
We'd also point out that Legal & General Group issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental - it's hard to grow dividends per share when new shares are regularly being created.
Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. First, we think Legal & General Group has an acceptable payout ratio. Earnings growth has been limited, but we like that the dividend payments have been fairly consistent. Legal & General Group might not be a bad business, but it doesn't show all of the characteristics we look for in a dividend stock.
Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For instance, we've picked out 1 warning sign for Legal & General Group that investors should take into consideration.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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