I don’t think the Aviva (LSE: AV) share price is likely to double by the end of the year. But I do think the valuation is too low right now. And I reckon there’s a good chance I could double my money by holding for the long term.
There are a few key reasons I think that, and I want to examine them today.
1 = dividend
The first is Aviva’s dividend. Forecasts suggest a dividend yield of 7.7% for the current year, based on today’s Aviva share price. That’s a very attractive yield, and it’s unusually high for the insurance sector.
What’s more, analysts expect the dividend to rise above 8% next year, despite the gloomy current global economy. Forecasts are risky, but even twice the share price would still give us a decent 4% yield. And if the dividend grows further in the coming years, a doubling could be plausible.
I think we’re looking at uncertainty now due to the share price trajectory in 2022. After a capital return via a B-share redemption scheme, the Aviva share price looks like it slumped this year. But adjusting for that, the shares are down just 2% over the past 12 months.
2 = valuation
The apparent fall in share price could well have investors fearing that something has gone wrong when it hasn’t. We’re looking at a forecast price-to-earnings (P/E) ratio of around nine, and that’s significantly below the FTSE 100 average, which current stands at approximately 14.
But as the company is heavily into financial services at a time when that sector looks like coming under increasing economic pressure, it could be that that’s a fair valuation today.
And if we see any dips in the dividend, that could well send the Aviva share price lower. That’s true even if it’s done simply for prudent cash management rather than any poor company performance.
But with a long-term perspective, I think Aviva shares are undervalued right now. And that, coupled with a progressive dividend, if that remains steady, could be a potent combination.
3 = pudding
Aviva has been through a few years of restructuring. It was widely seen as a bloated and inefficient, and needing to renew its focus. The company has largely achieved that, selling off non-core business as a key part of the process.
As a result of that, combined with significant cost-cutting, Aviva built up a pot of £4.75bn in spare cash to return to shareholders. That’s helping support the dividend, and there have been share buybacks too.
So why has the Aviva share price not enjoyed the upwards rerating that many of us had hoped for? I think the main problem is that investors have no idea yet how the new slimmed-down Aviva can perform. We have not yet seen the proof of the pudding. But when we do, things could be different.
Outlook
The new Aviva is emerging into an environment of soaring inflation, rising interest rates, and economic storm clouds.
So there’s plenty of short-term risk. And I half expect to see another year or two of Aviva share price weakness. But I do see long-term growth. And I’m happy to take the dividends while I’m waiting.