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This P/E Suggests Aviva plc is a Buy

The FTSE 100 has risen by more than 85% since it hit rock bottom in 2009, and bargains are getting harder to find.

I’m on the hunt for companies that still look cheap, based on their long-term earnings potential. To help me hunt down these bargains, I’m using a special version of the price to earnings ratio called the PE10, which is one of my favourite tools for value investing.

The PE10 compares the current share price with average earnings per share for the last ten years. This lets you see whether a company looks cheap compared to its long-term earnings.

Today, I’m going to take a look at the PE10 of insurer Aviva (LSE: AV) (NYSE: AV.US).

A turnaround story

Aviva’s turnaround plan aims to improve cash flow and generate growth, two principles that I am firmly in favour of as a shareholder!

The firm’s latest interim management statement reported a 10% fall in operating expenses, an 18% increase in new business, and a 9% increase in net asset value, suggesting that Aviva is making good progress.

Is Aviva a buy?

I’m looking forward to seeing the firm’s latest financials when its interim results are published on 8 August. These could give Aviva’s share price a further lift, if they live up to expectations.

However, as a value-oriented investor, I’m more interested in getting in before big price rises.

Aviva’s share price is 34% higher than it was a year ago, but it’s down by 5% on the start of this year — so does Aviva look cheap at the moment?

  Forecast
2013 P/E
PE10
Aviva 8.6 15.4

Aviva made a thumping loss last year, so I couldn’t use last year’s earnings to calculate a trailing P/E. Instead, I’ve used the broker consensus forecast earnings for this year to calculate the firm’s forward P/E, which is 8.6.

Despite this, it’s worth nothing that Aviva is trading at more than 15 times its average earnings from the last ten years. However, a closer look at the figures shows that the main reason for this is last year’s loss, and the smaller loss suffered in 2008.

Overall, this year’s forecast earnings of 42p per share are consistent with Aviva’s historic performance, and should not be too demanding to maintain, in my view.

I believe that Aviva’s recovery plan is progressing well, and I rate the shares a buy.

Can you beat the market?

If you already own shares in Aviva, then I’d strongly recommend that you take a look at this special Motley Fool report. Newly updated for 2013, it contains details of top UK fund manager Neil Woodford’s eight largest holdings.

Mr. Woodford’s track record is impressive: if you’d invested £10,000 into his High Income fund in 1988, it would have been worth £193,000 at the end of 2012 — a 1,830% increase!

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> Roland owns shares in Aviva.