Passive income shares are usually defined as stocks that provide a regular income through dividends. But I think this can be misleading. After all, only 38 of the UK’s 350 largest listed companies don’t pay a dividend. Overall, the FTSE 350’s presently (17 October) yielding 3.29%. However, by doing a bit of research, I think it’s possible to do a lot better than this.
For example, the highest-yielding share in my Stocks and Shares ISA is Legal & General (LSE:LGEN). With a return of 9%, it also happens to be the most generous on the FTSE 100. This is based on amounts paid over the past 12 months.
It used to be said a stock that’s yielding close to twice the return of that offered by 10-year government bond — used as a proxy for a ‘risk free’ rate of return — needs to be treated with caution. Although this is only a rule of thumb, it’s a useful guide when looking at passive income opportunities.
The current gilt rate’s 4.48%. Legal & General’s yield puts it just above twice this level.
Buyer beware
Sometimes, a generous yield is caused by a combination of a steady dividend and falling share price. That’s why high yields should be viewed with caution. And a look back over the previous five years, shows this is true (in part) with the FTSE 100 wealth provider.
Throughout the 2020s, Legal & General’s been yielding comfortably above the index average. But it’s started to move higher over the past three years or so, mainly due to a sluggish share price.
| Financial year | Dividend (pence) | Share price (pence) | Yield (%) |
|---|---|---|---|
| 2020 | 17.57 | 266 | 6.6 |
| 2021 | 18.45 | 298 | 6.2 |
| 2022 | 19.37 | 250 | 7.8 |
| 2023 | 20.34 | 251 | 8.1 |
| 2024 | 21.36 | 230 | 9.3 |
However, the stock has an impressive track record of increasing its payout. It was last cut during the 2008-2009 financial crisis. And was kept unchanged for one year during the pandemic. It’s pledged to increase it by 2% a year from 2025-2027. As is the fashion these days, it’s also recently completed a £500m share buyback programme.
Of course, there can never be any guarantees that its payout will be maintained indefinitely. The group faces increased competition in a sector that’s starting to attract some low-cost rivals. And it maintains a large investment portfolio to help meet its obligations to its insurance and pension clients. This means it faces the same risks and challenges as anyone else who invests in the stock market.
My view
But I think there are plenty of reasons why the group’s earnings will continue to grow, which increases the chances that its generous dividend can be sustained.
The group recently passed £200bn of assets under management (AUM) in its defined contribution pensions business. It has set itself a target of achieving inflows of £40bn-£50bn by 2028. Across all its divisions, it has £1trn of AUM. With 42% of these overseas, it’s not entirely dependent upon a UK economy that appears fragile.
It’s also winning from higher interest rates, which help push up annuity rates making them more attractive to pensioners. In addition, the group retains a strong balance sheet. It holds over twice the level of reserves that regulators require it to.
Principally due to the generous level of passive income on offer, I think Legal & General’s a stock well worth considering. However, recent history suggests its share price is unlikely to take off any time soon.
