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Legal and general (LSE:LGEN) shares have long been a core holding in my passive income portfolio.
I built this when I turned 50 a few years ago to maximize the income I was getting from dividend paying stocks.
This should allow me to further reduce my daily work commitments and live off the returns from these shares.
Portfolio adjustment for a 7%+ return
My minimum requirement for a stock to be included in this portfolio is an annual return of at least 7%. This is because the “risk-free rate” (the yield on 10-year UK government bonds) is around 4% and stocks carry risk.
If any of my passive income stocks fall below this yield, they are flagged for possible sale.
If the decline is due to an increase in the stock price, I would probably hold it as this is a technical adjustment, with stock prices and yields moving in opposite directions.
However, if it is due to a dividend cut, I would probably sell it. A dividend cut is never a good sign for a company, in my experience.
What is the performance outlook here?
Legal & General increased its interim dividend this year by 5%, from 5.71p per share in 2023 to 6p.
If this increase were applied to the 2023 total dividend of 20.34p, this year's total payout would be 21.36p. At the current share price of £2.23, this would give a yield of 9.6%.
This compares to the average FTSE 100 Index yield of 3.7% and the FTSE 250 Indexis 3.3%.
Looking ahead, consensus analysts expect these dividend payments to rise in 2025 to 21.9p and in 2026 to 22.5p. Again based on the current share price, these payments would give respective yields of 9.8% and 10.1%.
Ultimately, dividends are fed by profits over time. One risk here is that a further rise in the cost of living could cause customers to cancel their policies.
However, analysts forecast Legal & General's earnings will grow 27.3% each year until the end of 2026.
How much passive income can you generate?
I started investing in shares over 30 years ago with around £9,000. If I invested that amount now in Legal & General shares, I would get £819 thanks to its 9.1% yield.
If this average were the same over 10 years, you would earn £8,190, and over 30 years, £24,570.
It was certainly a pretty good return, but you could get a lot more if you used the dividends paid to buy more Legal & General shares.
The power of dividend compounding
This is called “dividend compounding” and is the same idea as letting interest grow in a bank account.
Using this method with the same average yield, you would get an extra £13,282 after 10 years, not £8,190. And after 30 years, on the same basis, you would get an extra £127,582 instead of £24,570.
Adding the original £9,000 to the total would give an investment of £136,582, which would yield a return of £12,429 a year at that point, or £1,036 a month.
Should I buy the shares?
I already own Legal & General shares because of their excellent performance, solid growth prospects and extreme undervaluation. I intend to buy more very soon for precisely the same reasons.