When I think of life insurance and financial services company Legal & General Group (LSE: LGEN), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.
1) Regulatory risk
According to Legal & General’s CEO, the firm traded well in the first two months of 2014 but external risks to the broader economy and markets remain. One of the uncertainties is how tapering of quantitative easing will affect demand for the firm’s offering.
However, Legal & General’s boss seems most concerned about the risk that political and regulatory uncertainty brings to economic progress. It’s no secret that financial institutions are facing intense scrutiny in the wake of the financial crisis and clumsy diktats could undermine the confidence of businesses to invest for long-term growth in the UK. That would create uncertainty for Legal & General, which the CEO reckons is the largest institutional investor in the UK.
2) Financial market gearing
Investors sometimes say that financial companies such as Legal & General ‘are geared to the financial markets’. On one level, that means that Legal & General’s share price tends to exaggerate the movements of the wider stock market, which itself tends to move to anticipate general economic conditions. On a deeper level, such wild movements in Legal & General’s share price are justified by the way the firm’s business profitability fluctuates according to the strength or weakness of the wider economy.
If we look at Legal & General’s business lines, they are all sensitive to wider economic cycles and profits will rise and fall in regular cycles. Last year, the firm earned 33% of operating profits from insurance, 23% from retirement products, 23% from investment management, 13% from investing its own capital and 7% from its American operations. When financial markets move down, investment earnings and commissions from investments fall. When economies tank and squeeze consumers’ incomes, demand for insurance products tends to fall. There’s no escaping the cyclicality inherent in Legal and General’s business, which could see investors in for a bumpy ride in the years ahead.
What now?
That forward dividend yield of 5.8% looks attractive, but I’m mindful of the cyclicality inherent in the financial services industry, which could hold back Legal & General’s share-price progress.