Aviva (LSE:AV) shares are popular with dividend investors. The insurance company has a strong dividend yield — 7.2% — and payments are supported by strong cash flows.
However, if I’d invested in Aviva shares a year ago, I’d be down 2.4%. That’s despite the company surging over the past three months.
So, a £1,000 investment would be worth £976 today. Thankfully I’d have received something in the region of £70 in the form of dividend payments.
What’s been going on?
After peaking in early 2023, the Aviva share price pushed down over the months to September. Aviva’s results during the period were positive but not exceptional.
One reason the stock fell was the fallout from the Silicon Valley Bank crash — which resulted in a major slump in the share price. The crash highlighted to many investors that financial institutions were sitting on billions of dollars of unrealised losses in the form of low coupon bonds.
However, the reality is most financial institutions — the well-managed ones at least — don’t need to sell these bonds. So, they remain unrealised losses.
Nonetheless, this event, and the continued upward movement of interest rates put further downward pressure on Aviva.
There are several ways interest rates impact share prices. The simplest is that when interest rates are rising, and capital moves away from shares and to debt and cash.
So, as expectations of interest rates cuts have risen, capital has started moving back from debt and cash to shares.
A safe dividend?
Insurers often maintain safe dividends due to their prudent financial management and risk assessment practices.
Insurance companies focus on long-term stability and must have sufficient reserves to cover potential policyholder claims.
It’s also the case that insurance companies have strong cash flows. After all, we tend to pay our insurance companies monthly for their cover.
By comparison, drugs companies may have to wait years for a new drug to go on sale.
However, this year it does appear that the coverage ratio isn’t too strong — around one. Dividend payments are likely to amount to around 31p, while analysts believe earnings per share will amount to 31.29p.
Nonetheless, earnings are expected to increase to 48.29p over the next two years. I’d still say these dividends are relatively safe.
Better value elsewhere
Aviva is currently trading 12% below its share price target. That’s not a bad sign, but I believe there is better value elsewhere on the FTSE 100 and within insurance. Aviva is currently facing several earnings headwinds in the near term, hence the lower dividend coverage ratio.
Nonetheless, earnings per share should pick up over the coming 24 months, and the industry is still benefitting from positive trends in the form of bulk purchase annuity, among other things.
But my preference is for Legal & General. The sector peer has a stronger dividend yield at 8.3%, a strong dividend coverage ratio, around two times, and is the market leader in bulk purchase annuity.
