As at 31 August 2016, Neil Woodford's Equity Income fund included Legal & General(LSE: LGEN) and Provident Financial(LSE: PFG) among its top 10 holdings. Both companies have disappointed in 2016, with Legal & General falling by 17% and Provident being down 2% year-to-date. However, both stocks have bright long-term futures.
Legal & General
Legal & General continues to perform well as a business. In its most recent results it recorded a rise in earnings of 14%, while return on equity stood at over 20%. Clearly, it faces risks from global economic challenges, but Legal & General offers at least some diversity, which should help it to overcome short-term difficulties in the pace of economic growth.
Furthermore, Legal & General offers a wide margin of safety. It trades on a price-to-earnings (P/E) ratio of just 10.5, which indicates that its shares could be due for an upward rerating. Having delivered profit growth in each of the last four years, Legal & General is forecast to increase its bottom line by 13% this year and by a further 2% next year. This could boost investor sentiment towards the company and push its share price higher.
Another reason why Neil Woodford may be a holder of Legal & General is its dividend outlook. It currently yields 6.5% from a dividend that's covered 1.5 times by profit. This indicates that Legal & General's dividend payments are sustainable and could rise rapidly over the medium-to-long term.
Lending company Provident also offers upbeat growth potential. It has benefitted in recent years from a low interest rate, which has helped to support UK economic growth. With the Bank of England adopting an increasingly dovish stance now, this could boost demand for new loans and make it easier for borrowers to pay back their earlier borrowings. As such, Provident's five-year run of earnings growth is forecast to continue over the next two years.
In fact, Provident is expected to increase its bottom line by 13% this year and by a further 7% next year. But despite such strong growth prospects, Provident currently trades on a relatively low valuation. For example, it has a price-to-earnings growth (PEG) ratio of 1.4 and this shows that its upbeat growth prospects are on offer at a very reasonable price.
As with Legal & General, Provident has upbeat dividend prospects. It currently yields 4% from a dividend that is covered 1.3 times by profit. With such strong profit growth, Provident is expected to raise dividends by 8.1% next year and further rises of a similar amount could be on the cards beyond 2017.
As such, Provident is a worthy buy right now alongside Legal & General. Although both stocks have underperformed the wider index in 2016, they have the potential to be strong performers in the future. This long-term appeal shows why they're backed by Neil Woodford.
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Peter Stephens owns shares of Legal & General Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.