Many investors like insurance shares because they perceive them as promising income choices. Customer demand for insurance tends to be resilient. A firm offering policies at the right price can make big profits, which fund dividends. That is one of the reasons my eye has been caught lately by Aviva (LSE: AV). Right now, Aviva shares have a dividend yield of 7.4%, which means that for every £1,000 I invest in them I would hopefully receive £74 in annual dividend income.
There are other appealing choices in the insurance sector at the moment too, though. Legal & General yields 7.0% and Direct Line 11.4%. So, should I make space in my portfolio for Aviva shares?
Big business, established reputation
I think Aviva has some notable strengths that help give it a competitive advantage.
It has a well-established reputation in key markets. Although its name has changed over the years, Aviva has been doing business for a very long time. In the UK, for example, the business can trace its history back more than 400 years. Financial services firms rely on the trust of their customers. If you pay a company money each year for home insurance, you want to feel confident that it will pay out if your house burns down. So Aviva’s long history and strong reputation are key assets in my view.
That can translate into substantial profits. Last year, for example, the company reported post-tax earnings of more than £2bn. But its current market capitalisation is a little below £11bn. That means that Aviva shares trade on a price-to-earnings ratio in mid-single digits, which sounds cheap to me.
Challenges ahead
However, the company faces risks.
It has radically and quickly reshaped its business over the past couple of years. That gives it more strategic focus and critical mass in key markets, which I see as positive for its business prospects. But it also makes the firm more reliant on just a few markets. That could hurt it if one of those markets becomes less profitable. For example, the UK’s regulatory changes this year on pricing of renewal premiums could hurt profits.
It has also made the firm less exciting from a growth perspective, which may explain the 22% fall in the value of Aviva shares over the past year. Selling off businesses raises cash, but reduces the long-term size of the business.
Although it was sprawling before, which likely made it harder to manage, the firm now is mostly focussed on mature markets. Rivals like Prudential can benefit from strong growth stories in Asia. By contrast, Aviva has mostly retreated to proven but slow-growing markets.
My move on Aviva shares
The shift in business strategy was accompanied by a dividend cut. Last year’s final dividend was smaller than it had been five years before, for example. The dividend grew last year, but the firm has demonstrated its willingness to reduce it as the business evolves.
The yield is appealing to me. But the company seems less dynamic compared to rivals with a growth story I find more compelling, like Legal & General. For that reason, I will not be adding Aviva shares to my portfolio right now.