The Income Investor: does L&G offer income investing appeal?

Investors have enjoyed double-digit capital returns and significant dividend income since he first backed this FTSE 100 dividend. Now, analyst Robert Stephens discusses capital growth potential and red flags.

10th June 2025 09:07

Robert Stephens from interactive investor

Income investors face a continual trade-off between an attractive dividend yield and strong dividend growth potential. Indeed, it is extremely rare to unearth companies that offer both attributes in equal measure.

Some stocks offer highly appealing yields that are well in excess of the wider index’s income return. However, they often lack the potential for fast-paced dividend growth. This is usually caused by modest earnings growth prospects that only allow them to raise shareholder payouts at a limited rate.

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Conversely, other companies may be able to deliver rapid increases in shareholder payouts due to improving financial performance. However, this may lead to bullish investor sentiment that causes their share price to surge higher, thereby resulting in a relatively lacklustre yield vis-à-vis the wider index.

Inflation forecasts

Given that inflation has been above the Bank of England’s 2% target for much of the past four years, and currently stands at 3.4%, many income investors may understandably have favoured strong dividend growth potential over an attractive dividend yield in the recent past. After all, there seems to be little point in obtaining a generous income return today only for it to decline noticeably in real terms over an extended period amid a rapid rate of price increases.

However, the current outlook for inflation may mean that the prospect of strong dividend growth becomes less alluring. The Bank of England forecasts that while inflation will rise by a further 30 basis points to 3.7% by September this year, it will then fall to its 2% target over the medium term.

This would be more in keeping with historical levels of price rises. Indeed, even when recent rampant levels of inflation are considered, annual price rises averaged just 2.4% between 1994 and 2024. If a similar rate remains present over the coming years, even those firms that have previously been viewed as offering only modest growth in shareholder payouts could still produce positive real-terms growth in dividends over the long run.

As a result, investors may be more willing to focus on firms that offer a mixture of a relatively high yield and modest dividend growth that still at least matches anticipated inflation over the coming years. Such companies may provide them with a generous income that maintains its spending power over the long term, thereby meeting what are likely to be two of their main aims.

	Yield (%)
Asset	Current	14-May	Change (May-current) %	08-Apr	12-Mar	11-Feb	15-Jan	09-Dec	12-Nov	15-Oct	11-Sep	31-Jul	09-Jul	05-Jun
FTSE 100	3.42	3.55	-3.7	3.98	3.63	3.50	3.73	3.68	3.75	3.70	3.72	3.69	3.72	3.70
FTSE 250	3.83	3.89	-1.5	4.51	3.97	3.75	3.99	3.70	3.75	3.74	3.70	3.59	3.72	3.77
S&P 500	1.57	1.60	-1.9	1.82	1.64	1.52	1.56	1.50	1.51	1.52	1.61	1.63	1.59	1.65
DAX 40 (Germany)	2.37	2.42	-2.1	2.86	2.63	2.59	2.75	2.66	2.79	2.78	2.98	2.95	2.94	2.97
Nikkei 225 (Japan)	1.94	1.89	2.6	2.19	1.86	1.75	1.75	1.72	1.67	1.59	1.74	1.60	1.54	1.61
UK 2-yr Gilt	4.030	3.979	1.3	3.964	4.163	4.156	4.498	4.248	4.449	4.132	3.802	3.815	4.142	4.379
UK 10-yr Gilt	4.626	4.672	-1.0	4.586	4.678	4.475	4.817	4.269	4.445	4.168	3.773	3.970	4.141	4.214
US 2-yr Treasury	3.945	4.000	-1.4	3.769	3.937	4.279	4.356	4.124	4.309	3.950	3.571	4.354	4.635	4.787
US 10-yr Treasury	4.410	4.469	-1.3	4.185	4.272	4.515	4.774	4.192	4.357	4.034	3.616	4.103	4.292	4.344
UK money market bond	4.46	4.53	-1.5	4.53	4.65	4.80	4.80	4.91	5.00	5.02	5.22	5.29	5.32	5.19
UK corporate bond	5.74	5.63	2.0	5.65	5.69	5.71	5.74	5.79	5.70	5.78	5.81	5.83	5.86	5.81
Global high yield bond	6.54	6.34	3.2	6.55	6.52	6.63	6.66	6.72	6.60	6.56	6.68	6.73	6.85	6.83
Global infrastructure bond	2.24	2.24	0.0	2.32	2.27	2.34	2.42	2.27	2.24	2.22	2.24	2.30	2.44	2.39
SONIA (Sterling Overnight Index Average)*	4.2111	4.2103	0.0	4.4554	4.4548	4.4544	4.70	4.70	4.70	4.95	4.95	5.200	5.200	5.200
Best savings account (easy access)	4.75	5.00	-5.0	5.00	5.00	5.00	5.00	4.85	4.87	5.20	5.20	5.20	5.20	5.20
Best fixed rate bond (one year)	4.45	4.52	-1.5	4.70	4.58	4.75	4.77	4.80	4.80	5.00	5.00	5.40	5.26	5.22
Best cash ISA (easy access)**	4.85	4.83	0.4	5.92	5.00	5.03	5.05	5.18	5.17	5.10	5.00	5.20	5.20	5.17

Source: Refinitiv as at 6 June 2025. Bond yields are distribution yields of selected Royal London active bond funds (as at 30 April 2025), except global infrastructure bond which is 12-month trailing yield for iShares Global Infras ETF USD Dist as at 4 June. SONIA reflects the average of interest rates that banks pay to borrow sterling overnight from each other (4 June). *Data prior to May is based on 3-month GBP LIBOR. Best accounts by moneyfactscompare.co.uk refer to Annual Equivalent Rate (AER) as at 6 June. **Best rate includes 12-month bonus.

Cyclical stocks

Of course, the rate of dividend growth generated by any stock is perennially uncertain. It is dependent on an almost infinite number of variables, both within the company and in the wider economy, that can fail to meet investor expectations.

Given the ongoing global trade war, it is arguably even more difficult at present to accurately forecast the financial performance of companies. This means that estimating their dividend growth rates is equally challenging.

Therefore, it may be prudent for investors to focus on the cyclicality of a company before purchase. Firms that are highly reliant on the economy’s performance may offer strong dividend growth over the long run. However, an uncertain near-term economic outlook may mean their capacity to raise shareholder payouts rapidly over the short run is far more limited.

Dividend payout ratio

Equally, investors may wish to consider the level of dividend cover offered by a prospective purchase. If a firm’s payout ratio is relatively high, this suggests it may struggle to maintain its dividend should a tough operating environment emerge. This could mean that while it has a relatively high yield, the income return offered could come under pressure over the long run.

A company with a modest level of dividend cover may also find the task of raising dividends relatively difficult even during a period of brisk profit growth. It could, for example, seek to moderate its payout ratio to repay debt or invest in improving its competitive position.

Therefore, focusing on firms whose profits easily cover dividends could prove to be highly worthwhile for all income-seeking investors.

Slowing dividend growth

FTSE 100 constituent Legal & General Group (LSE:LGEN) raised dividends per share by 5% in its latest financial year. However, the company announced in its latest full-year results that it will now target a 2% annual rise in dividends per share over the next three years.

This means that while its shareholder payouts grew at a faster pace than inflation in 2024, when annual price rises amounted to 2.5%, dividend growth is now set to only be in line with the central bank’s 2% target over the medium term.

This could mean that investors in the diversified financial services company fail to experience a substantial rise in their spending power over the coming years. Their purchasing power could even come under a degree of pressure if inflation remains above the Bank of England’s target in future.

A high yield

However, Legal & General’s highly attractive dividend yield appears to more than compensate income investors for a prospective slower rise in shareholder payouts. The firm’s income return currently amounts to 8.4%, which is almost 500 basis points ahead of the FTSE 100 index’s dividend yield.

Furthermore, the company has a strong track record of reliable dividend payouts. For example, after holding dividends at their 2019 level during 2020 amid an uncertain operating environment caused by the pandemic, it has raised shareholder payouts by 5% in each of the following four years.

The company, of course, benefits from its status as a mature business that operates across a variety of sectors. This provides a relatively stable financial performance that equates to a more reliable dividend than for less mature, pure-play businesses.

Earnings outlook

Legal & General’s dividends were not fully covered by profits in its latest financial year, with its payout ratio amounting to 106%. This means that for every £1 in profits earned, the company paid out £1.06 to its shareholders in the form of dividends.

While this is unsustainable in the long run, the firm’s bottom line is forecast to rise at a significantly faster pace than dividends over the coming years. According to consensus market forecasts, for example, the company’s earnings per share are set to increase by 13% this year and by a further 10% next year. Assuming a 2% annual rise in dividends over the same period, the company’s shareholder payouts are set to be covered over 1.1 times by profits in 2026.

Although this remains relatively modest, in terms of how many times dividends may be able to be paid with profits, the firm’s diverse range of operations and strong long-term track record of financial performance mean it nevertheless appears to have a favourable income investing outlook.

Total return prospects

Legal & General also offers upbeat capital growth potential. It currently trades on a forward price/earnings (PE) ratio of around 11.1, which suggests there is scope for an upward rerating given double-digit earnings growth forecasts over the next two years. Additionally, it means that a £500 million share buyback programme announced for this year appears to be highly logical.

Since first being discussed in this column during May 2023, the company’s share price has risen by 10%. While this is three percentage points behind the FTSE 100 index’s capital return over the same period, Legal & General’s income return of 18% means total return amounts to roughly 28%.

While the company’s lower rate of prospective dividend growth and relatively high payout ratio may be considered red flags by some investors, the firm’s high yield, low valuation and upbeat financial outlook mean it appears to offer long-term investment potential.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.

These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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