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Legal and general (LSE: LGEN) has long been a star financial stock in the FTSE 100. However, since early March, its share price has fallen.
I think the key reason for this was market nervousness around the minibank crisis at the time. This was due to the collapse of the little-known Silicon Valley Bank and increased with the bankruptcy of Credit Suisse.
Naturally, fear of a new financial crisis remains a risk for stocks. Another is that inflation and interest rates remain high, deterring new customers from doing business.
However, the 17% drop seen in Legal & General shares since then seems completely unjustified to me.
Solid core business
From the start of its five-year plan in 2020 to the end of 2022, it achieved cash generation of £5.1bn. It also achieved £4.9bn in cumulative capital generation.
In its 2022 results it said that even zero growth in both metrics between now and 2024 would allow it to generate between £8bn and £9bn in accumulated cash and equity.
Another sign of the strength of its balance sheet was the increase in its Solvency II ratio to 236% in 2022. A coverage of only 100% for an investment and insurance company meets all regulatory requirements.
It’s a bargain?
Just because a stock has fallen sharply doesn’t necessarily mean it’s undervalued. It may simply be that the business itself is worth less now than it was before.
To determine if a company is undervalued, I start by comparing its price-to-earnings (P/E) ratio to its peers.
Currently Legal & General is 6.6, Prudentialis 8.6, Hansard Globalis 13.2, Admiralis 19.4, and beazleyis 29.8.
Therefore, Legal & General appears undervalued on this measure compared to its peer group.
How much is it undervalued?
I think the best way to answer how much is by using discounted cash flow (DCF) valuation. Given the assumptions involved in this, I don’t rely on my numbers, but instead look at various analysts’ DCF valuations.
The basic assessments of Legal and General are undervalued by between 50% and 57%. Taking the lowest of these would give a fair value per share of £4.44.
This doesn’t mean the stock will reach that point, of course. But this underlines to me that the shares currently offer very good value.
Large stock of passive income
Last year, Legal & General paid a total of 19.37 pence per share. Based on the current share price of £2.22, this gives a yield of 8.7%.
Its interim dividend this year was 5.71p, compared to 5.44p last year. This suggests to me that this year’s total dividend may be even higher than last year’s.
Even if the return remains the same, an investment of £10,000 would generate £870 this year. Over 10 years, if the rate remained the same, this would total £8,700 to add to the initial investment of £10,000. This goes beyond gains or losses in share price and tax liabilities incurred, of course.
Although I already own shares in the company, I am seriously considering buying more. I think at some point it will recover all of this year’s 17% loss. I also believe that over time it will gradually converge towards its fair value, in addition to paying excellent dividends.
