Interest rates have fallen to new lows during the pandemic. The bank I use for my current account — a big high street name — now offers 0.01% interest on its savings accounts. In other words, just-about-zero interest. In this environment, I’m relying more heavily than usual on dividend stocks for income.
Today I want to look at a FTSE 100 stock that offers a 2020 forecast yield of 7.7%. As I’ll explain, I think this payout should be sustainable. It’s also a share I’d like to buy.
Much better than banks
The company I’m going to look at today is Legal & General Group (LSE: LGEN). The pension and insurance group has been a big winner since the financial crisis. L&G has delivered a share price gain of 150% over the last 10 years.
By contrast, the FTSE 100 has only gained about 10% over the same period, while Lloyds Banking Group‘s share price has fallen by 45% since November 2010.
Legal & General shares have slumped this year, but this dividend stock has still performed well for shareholders over the last decade. I now need to decide if the company can maintain this record over the next few years.
There have been big changes to the pension market in recent years, but Legal & General has adapted by becoming a big player in the bulk annuity market. Essentially companies sell their pension schemes to firms like Legal & General, who accept responsibility for all future pension payments.
L&G’s specialist skills and economies of scale mean this has become a profitable business that sits well alongside its life insurance and asset management businesses. All three require a mix of short and long-term investments that provide reliable cash flows. The group has used its size to expand into new areas such as property. This has helped to overcome the challenges caused by ultra-low interest rates.
The group’s success is reflected in its profitability. Legal & General’s return on equity has averaged almost 20% since 2014, which is well ahead of more traditional insurers like Aviva and Prudential.
Why I’d buy this dividend stock
Cash generation is key for a dividend stock. Big profits are not much use unless they’re supported by reliable cash flows. Fortunately, Legal & General has consistently scored well in this area in recent years.
In 2019, the group’s after-tax profit of £1,700m was almost exactly matched by cash released from its operations of £1,606m. This covered the £1,048m dividend comfortably.
2020 looks likely to be a more difficult year, but my sums suggest the dividend should still be covered by surplus cash. Therefore I’m confident Legal & General’s 7.7% dividend yield should be sustainable.
I see this firm as a reliable dividend stock that I could hold for many years. The main risk I can see is that something unforeseen will happen that will disrupt the group’s business model. This could be a financial market event or a regulatory change. I don’t think it’s likely, but it will always be a possibility.
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Roland Head owns shares of Aviva. The Motley Fool UK has recommended Lloyds Banking Group and Prudential. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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