When seeking passive income, investors frequently prioritize dividend yields. This approach is logical, as the yield provides a quick snapshot of the annual income a share might produce relative to its current market price.
However, fixating on this single metric can lead to expensive errors. While a high yield might indicate a generous and sustainable payout, it can also suggest that the share price has plummeted due to underlying concerns about the company’s health.
I believe this distinction is vital. Since passive income is intended to be reliable, the quality of the dividend deserves as much scrutiny as the yield itself.
There are several reasons why income-focused investors must look beyond the headline percentage. Even when a company’s business model supporting the dividend, rather than simply focusing on the figure displayed on a screen.
Legal & General as an example
Legal & General (LSE:LGEN) is often a preferred choice for income investors due to its high yield, which is supported by a diverse array of financial products and services, including insurance, asset management, and retirement solutions.
This diversification makes the shares attractive to those seeking a consistent income stream from a well-known UK institution.
The most recent half-year results provided supporters with encouraging data. Core operating profit climbed 7% to £918m, while core operating earnings per share (EPS) rose 11% to 12.15p. Additionally, the company increased its 2026 interim dividend by 2%, moving from 6.12p to 6.24p per share. This hike aligns with its stated guidance of 2% annual dividend growth for the 2025-2027 period.
Furthermore, the firm anticipates that its 2026 core operating EPS will exceed the upper limit of its 6%-9% target range. Such performance should bolster confidence among investors considering the stock for their income portfolios.
Nevertheless, the stock is not without its risks.
Why the yield could be a trap
The primary risk involves dividend cover. Although earnings growth is impressive, L&G must still distribute a significant portion of its profits as dividends. Should earnings decline, the company might find it difficult to maintain these payments without relying on debt or cash reserves. Consequently, investors should evaluate the dividend against earnings, capital requirements, and cash generation rather than assuming any payout is guaranteed.
The second risk is exposure to the business cycle. Financial services firms are susceptible to shifting market conditions, interest rate fluctuations, competition, and changes in demand for retirement products. A strong half-year performance does not guarantee that future periods will be equally successful.
