During 2013, I’ve looked at most shares in the FTSE 100 and graded them against these five quality and value indicators:
- Dividend cover
- Borrowings
- Growth
- Price to earnings
- Outlook
Some companies scored highly against the “business quality” indicators of level of borrowings, earnings growth record, and outlook. Others scored highly against the “value” indicators of dividend cover and price-to-earnings ratio (P/E).
Quality and value in harmony
However, the most promising investment opportunities scored well on both business quality and value indicators.
In this mini-series, I’m revisiting some of the highest-scoring shares to look at events since the original article and to assess the quality of the investment opportunity now. Some of these high-scoring firms could be investment winners for 2014 and beyond so, today, I’m revisiting life and general insurance company Aviva (LSE: AV) (NYSE: AV.US), which scored 18 out of 25 in May.
A turnaround starting to turn
At the end of May, with the share price at 330p, I was optimistic about Aviva’s total-return prospects as a turnaround investment. Today the shares stand at about 441p, and a glance at the recent third-quarter interim management statement helps to explain why the share price has progressed.
The Combined Operating Ratio, a measure of underwriting business performance, is running at around 96.9% up from 96% last time I looked. Anything below 100% means insurance operations are making profit so, despite making losses in some geographic areas such as Spain, Italy and Ireland, overall insurance operations have remained profitable through the period.
During the first nine months of Aviva’s trading year the Value of New Business (VNB) improved 14% to £571 million compared to £503m a year ago, signalling good progress on growth. The firm’s main cash-generating areas, UK and France, increased VNB by 5% and 33% respectively, whilst the growth markets of Poland, Turkey and Asia increased VNB by 44%. That’s significant because those growth areas contributed around 22% of Aviva’s overall new insurance business, up from 18% a year ago, demonstrating the gathering importance of these up-and-coming economies to the firm’s growth plans.
Much still to do
In Spain and Italy the value of new business fell from £32m to £19 million and from £19m to £7 million respectively, which is one reason that the CEO reckons, “The turnaround at Aviva is still in its infancy; we have made progress this year and whilst there is room for optimism there remains much to do.“
Forecasters expect forward earnings to cover the dividend almost three times in 2014, so I’m keeping my dividend-cover score at 4/5. Meanwhile, the firm’s declared borrowings suggest gearing around 100% against net tangible assets, scoring 3/5 from me, but there’s a lot of ‘hidden’ liability thanks to Aviva’s massive investment operation, which earns the firm most of its income.
Recent progress with earnings means I’m happy to increase my growth rating from two to 4/5.
Valuation
A forward P/E rating of 9.4 compares well to expectations of 9% growth in earnings and a 3.6% dividend yield for 2014, so I’m happy maintain my P/E-score at 4/5. The CEO’s recent cautious noises prompt me to drop the outlook score from four to 3/5.
Overall, I score Aviva 18/25 now, the same as in May, although the composition of the score has changed a little.
What now?
Aviva’s CEO says that Aviva’s turnaround has a long way to go. If the firm can continue to make operational progress, the relatively undemanding valuation could see shareholders benefit too. That said, I’m likely to use dividend yield as a guide, and on that measure, Aviva has become less attractive since the recent strong share-price rise.
