This Model Suggests Aviva plc Could Deliver A 10.4% Annual Return

Roland Head explains why owning Aviva plc (LON:AV) shares could deliver an annual return of 10.4% over the next few years.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

One of the risks of being an income investor is that you can be seduced by attractive yields, which are sometimes a symptom of a declining business or a falling share price.

Take Aviva (LSE: AV) (NYSE: AV.US), for example. Broker consensus forecasts suggest that the firm offers a 3.6% prospective yield, which is attractive. But 3.6% is substantially less than the long-term average total return from UK equities, which is about 8%.

Aviva’s share price has risen by 32% over the last 12 months and is close to its post-2008 high. Can it keep rising to enhance Aviva’s total return?

Should you invest £1,000 in Phoenix Group Holdings Plc right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Phoenix Group Holdings Plc made the list?

See the 6 stocks

What will Aviva’s total return be?

Looking ahead, I need to know the expected total return from my Aviva shares, so that I can compare it to my benchmark, a FTSE 100 tracker.

The dividend discount model is a technique that’s widely used to value dividend-paying shares. A variation of this model also allows you to calculate the expected rate of return on a dividend paying share:

Total return = (Prospective dividend ÷ current share price) + expected dividend growth rate

Last year’s 40% dividend cut means my usual averaged dividend growth approach will give a heavily skewed result, so I ‘ve calculated Aviva’s potential returns using next year’s forecast dividend growth. Here’s how this formula looks for Aviva:

(15.5 ÷435) + 0.0685 = 0.104 x 100 = 10.4%

My model suggests that Aviva shares could deliver a total return of 10.4% per year over the next few years, modestly outperforming the long-term average total return of 8% per year I’d expect from a FTSE 100 tracker.

Isn’t this too simple?

One limitation of this model is that it doesn’t tell you whether a company can afford to keep paying and growing its dividend.

My preferred measure of dividend affordability is free cash flow — the cash that’s left after capital expenditure and tax costs.  One of the reasons that Aviva cut its dividend last year was to improve cash flow — a prudent objective I approve of, albeit uncomfortable for shareholders like me.

Free cash flow is normally defined as operating cash flow – tax – capex.

Aviva’s free cash flow in 2012 was £2.2bn, comfortably covering its £647m payout. However, free cash flow was boosted by the proceeds of asset sales and fund raising, without which the firm’s cash flow would have been much tighter.

But here’s another bargain investment that looks absurdly dirt-cheap:

Like buying £1 for 31p

This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

See the full investment case

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

> Roland owns shares in Aviva.

Our best passive income stock ideas

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

More on Investing Articles

Investing Articles

Up 30% in weeks, does the BAE Systems share price still offer value?

The BAE Systems share price has been on a tear over the past couple of months. This writer sees limited…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Hunting for shares to buy as the market trembles? Remember this!

After a choppy week in global stock markets, our writer goes back to basics in his hunt for bargain shares…

Read more »

Investing Articles

3 simple principles to help build wealth in an ISA

As a new tax year opens up new ISA allowances for many investors, our writer shares a trio of things…

Read more »

Investing Articles

US trade tariffs: what they could mean for UK shares like Ashtead, Compass Group, and Experian

US trade tariffs continue to rock global markets, and the UK is no exception. Our writer considers how a new…

Read more »

Mindful young woman breathing out with closed eyes, calming down in stressful situation, working on computer in modern kitchen.
Dividend Shares

The Trump slump has smashed these FTSE 100 shares!

After a rough week for US and UK shares, investors have been shaken. But now these FTSE 100 stocks have…

Read more »

Investing Articles

£10,000 invested in Rolls-Royce shares 5 years ago is now worth…

Rolls-Royce shares have been on fire since April 2020. Part of this is the result of pandemic restrictions lifting, but…

Read more »

Young Asian woman with head in hands at her desk
Investing Articles

£10,000 invested in Tesla stock at its peak in 2024 is now worth…

Over the last few months, Tesla stock has lost nearly half its value. Here, Edward Sheldon explores a few takeaways…

Read more »

Investing Articles

Is the S&P 500 heading for an epic stock market crash?

Our writer shares his thoughts on a very crazy time for the S&P 500 and the wider stock market. How…

Read more »