Is an interest rate of 1.45% enough to help you build a worthwhile pension pot? Probably not. That’s why I put most of my savings in the stock market, except for a rainy day fund which I keep in cash.
One of the oldest holdings in my portfolio is FTSE 100 insurance giant Aviva (LSE: AV). I’ve bought more shares on several occasions in recent years, most recently at the start of this year, when I thought the shares were simply too cheap.
I keep buying because, over the last five years or so, Aviva’s management has done exactly what it promised to do. Focus on fewer, larger operations. Cash flow has improved and debt has been repaid. Shareholders have benefited from a rising stream of dividends.
For much of this time, the share price has remained weak, resulting in very attractive dividend yields. For example, my most recent purchase came with a yield of 8%.
Surely something’s wrong?
Such high dividend yields are often a sign of problems to come. There are certainly a few clouds on the horizon. Brexit is one risk, although I don’t think it’s likely to cause too much disruption.
A more serious concern is that Aviva has been without a chief executive since October. As my colleague Rupert Hargreaves explains, investors are unlikely to give the company much love while it lacks leadership.
Despite these risks, my policy is to continue holding dividend stocks such as Aviva unless I can see evidence of serious problems. I’m sure a new CEO will be appointed in due course. In the meantime, the shares are trading on 7.1 times 2019 earnings, with a forecast yield of 7.8%. I think that’s too cheap.
Investors do love this stock
One insurance company that is loved by investors is motor and home insurer Admiral Group (LSE: ADM). The share price has risen by about 190% over the last 10 years. One reason for the group’s outstanding performance is that it’s unusually profitable.
For example, Aviva reported a return on equity — a measure of profitability for financial firms — of 12.7% during the first half of 2018. That’s respectable, but not amazing.
In contrast, Admiral generated a return on equity of 54% during the same period. This very high level of profitability is partly down to the company’s business model. It outsources the risk of many of its insurance policies to other insurers, in return for a fixed payment. The advantage of this is that it reduces the amount of capital needed to be held by the firm. In turn, this frees up a lot of cash for dividends.
The company’s dividends are certainly a huge draw for investors. In most years, the firm pays out more than 90% of earnings in the form of dividends. For example, last year it paid 114p to shareholders from total earnings of 117.2p.
The right time to buy?
I think it’s fair to expect Admiral shares to trade at a higher valuation than less profitable rivals. But I’m starting to think the shares look quite fully priced. Forecasts for 2019 put the stock on a price/earnings ratio of 16.4 with a dividend yield of 6.1%.
I believe Admiral is a great business. But at this price, I’d rate the stock as a hold rather than a buy.