Aviva (LSE: AV.) shares at £4 have caught my eye recently. At that price, they’re forecast to pay out some quite hefty passive income over the next couple of years.
Plus, with the FTSE 100 insurance group pivoting towards a capital-light model, maybe the share price might get a nice boost, eventually, one day.
If both things happen, then I’d be looking at arguably the Holy Grail of investing. And that’s a rising share price coupled with increasing dividends, the lucrative one-two combination that has made Warren Buffett so successful/rich.
On 25 September, Aviva announced that it will buy American International Group‘s UK protection business for £460m.
This isn’t a particularly large acquisition for a company with a market cap of £10.9bn. But it does add 1.3m individual protection customers and 1.4m group protection members to its business. And it should be largely funded, I’d assume, by recent disposals.
Additionally, the firm has reassured investors that its “estimated impact on the Group’s Solvency II shareholder cover ratio would have been a reduction of [around 5%] points as at 30 June 2023“. So that’s not too worrying.
Finally, the insurer still anticipates regular and sustainable capital returns. That is, this acquisition isn’t expected to affect dividend payments and share buybacks. Aviva expects to repurchase up to £300m worth of shares this year.
Passive income potential
The Aviva share price has dropped 10% year to date and 39% over five years. While that’s no doubt disappointing for existing shareholders, I reckon it presents new investors with an attractive entry point for potentially very rewarding passive income.
That’s because the stock carries a colossal forward-looking dividend yield of 8.7% for next year. For 2025, some analysts see it rising above 9%. That would make it one of the highest yields on the London Stock Exchange.
For context, that means I could generate around £360 in passive income off a £2k investment in Aviva shares by 2026. I could earn more in the years after that, potentially.
That sounds fine with me, though these forecasts could soon change.
After all, the financial performance of insurance firms is highly influenced by the economy. During economic downturns, for example, people tend to rethink their insurance coverage or cancel policies, which can damage profits (and payouts).
On the other hand, during periods of economic expansion, firms like Aviva can see rising demand for insurance as new businesses grow and people spend more money.
But the UK economy isn’t expected to do lots of expanding. And, as things stand, Aviva’s payout for 2024 is only covered 1.37 times by expected earnings. So the dividend would barely be covered, leaving little margin of safety if economic conditions worsen.
That said, I do like the firm’s focus on capital-light growth. This is centred around cost efficiencies and growing synergies in its businesses (between insurance and wealth management, for example). Progress here might even support a higher share price.
All things considered, I think Aviva stock is worth the risk at £4. It should make a nice passive income pairing in my portfolio next to Legal & General, another insurer sporting a huge dividend yield.