Should I buy Aviva shares for a 7.4% dividend yield?

Christopher Ruane mulls whether the potential to double his money in under a decade by compounding dividends means he should buy Aviva shares.

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The prospect of sitting back and hopefully earning dividends year after year from a FTSE 100 share appeals to me. Dividends are never guaranteed though. So when looking at a stock with an attractive dividend yield I also pay a lot of attention to how good the underlying business is. Insurer Aviva (LSE: AV) has a yield of 7.4%, which certainly grabs my attention. But how attractive might Aviva shares be for a long-term buy-and-hold investor like myself?

The long-term investment case

Over the past few years, Aviva has slimmed down its operations to focus on core markets. In the long run, that can make a business more profitable as it applies its resources where it has a strong chance to succeed.

Aviva’s area of business is attractive to me as an investor thinking far into the future. Its roots stretch back hundreds of years, underlining the fact that demand for insurance tends to be resilient. I expect the size of the insurance market to stay large in the long term.

Last year saw operating profits at Aviva surge 35%, to £2.2bn. But using the IFRS accounting standard, the company reported a loss of £1.1bn. Insurance company accounts can be difficult things to understand, as revenues come in on a short-term basis, but liabilities are often accounted for through a much longer-term perspective. I think profit at the operating level is impressive. I reckon Aviva’s more focused business, strong brands and long underwriting experience could help it do well in future.

The annual dividend was increased 40% to 31p per share in the most recent annual results. With Aviva shares currently selling for around £4.20 each, that looks attractive to me. Indeed, it aims to deliver what it describes as “an attractive and sustainable dividend”.

Payouts are never guaranteed, however. The final payout for 2019 was cancelled, for example. But if the insurer is able to sustain the dividend at today’s level, I like the income prospects of owning these shares. If I compound an annual 7.4% dividend yield and the shares stay at the same price, I would expect to double my money in under a decade.

Should I buy?

I looked at Aviva shares a few months ago and decided that I would wait to see what happened to the dividend before adding them to my portfolio.

There are always risks with insurance shares (even though risk management is their business). Inflation could add to claims settlement costs. Indeed, that was one reason rival Direct Line axed its dividend earlier this year.

But the recent large dividend increase means that I now think Aviva offers me a stake in a great business at an attractive price – with strong income prospects. If I had spare cash to invest today, I would add the stock to my portfolio.

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.

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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