The Aviva (LSE:AV) share price has been on a roll recently. Over the past 12 months, it has increased by over 50%, and the stock is now trading near pre-pandemic levels.
Can the Aviva share price continue its upward momentum though? And is it too late to add the business to my portfolio?Â
Aviva’s rising share price
Aviva is a financial services firm that specialises predominantly in life insurance and pension products. The business charges its insurance customers premiums and its investment customers service fees. But that’s not actually how this company generates profits.
Like all insurance companies, Aviva uses its operational cash flow to invest in various financial instruments, including shares. It then subsequently uses the returns on these investments to cover claim expenses and grow the business in general. So when the stock market crashed in March 2020, Aviva took a significant hit to its investment portfolios and even had to cancel its full-year dividends.
Since then, the stock market and, subsequently the Aviva share price, have begun to recover. What’s more, the company is shifting its strategy to only focus on the UK, Irish, and Canadian markets. And so, throughout 2020, it began disposing of its international operations in Singapore, Hong Kong, Indonesia, Turkey, and more recently, France and Italy.
These disposals provided a surge in cash on the balance sheet and also enabled the dividend to return, with the next ex-dividend date set for 8 April.
Risks to consider
Running an insurance business is a relatively risky endeavour. The monthly insurance premiums paid by an individual rarely cover the costs if a claim is made (although, of course, not all customers make claims). A simple solution to this problem would be to charge higher premiums. But with so many other competing insurance businesses for customers to choose from, Aviva’s pricing power is virtually non-existent.
Beyond its insurance business, the firm is also exposed to risks revolving around medical innovations. Average life expectancy has been steadily increasing over the past 40 years due to general healthcare improvements. However, this has added pressure to Aviva’s pension products. For example, annuities have become far less lucrative over the years — a trend that will likely continue over the long term.
To mitigate these risks, Aviva uses those aforementioned investments to grow its capital. But consequently, this exposes it to market risk, which can cause severe financial damage, as perfectly demonstrated last year. The volatility in its investments has also led to an inconsistent dividend track record, with cuts being made multiple times even before the pandemic.
The bottom line
The disposal of most of its international operations has flooded the business with fresh capital that could lead to substantial future growth. And even though Aviva’s share price has significantly risen these past few months, it is still trading at a P/E ratio of around 8. Comparing that to its industry average of 12.5, the stock does look undervalued to me.
Therefore, over the short-term, I think it is possible for the Aviva share price to keep on climbing. But its long-term growth potential is tied to the new strategy which remains unproven for now. So, I won’t be adding Aviva to my portfolio today.