1 dividend star I’d buy over Lloyds shares without hesitation

This high-yielding FTSE 100 star is more undervalued than Lloyds shares, has better growth forecasts, and can make much higher passive income.

| More on:
Person holding magnifying glass over important document, reading the small print

Image source: Getty Images

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.

The main reason I sold my Lloyds (LSE: LLOY) shares recently is that they trade like a penny stock. They are not one strictly speaking, as their market capitalisation is too big.

Nonetheless, each penny represents around 2% of the share’s value, making the risk simply too great for me.

With the proceeds, I increased my holdings in several other shares. These all have a much higher dividend yield than Lloyds, a stronger business outlook, and appear more undervalued. One of these was insurance and investment firm Aviva (LSE: AV).

Business outlook

Rising earnings and profits are what drive a company’s dividends and share price higher over time.

Consensus analysts’ estimates are that Lloyds earnings and revenue will increase by 4.8% and 3.2% a year, respectively, to end-2027.

Aviva’s earnings and revenue are projected to rise, respectively, by 8.4% and 5.4% a year to the end of 2027.

Lloyds also looks riskier to me, even leaving aside its greater price volatility exposure.

It faces declining net interest margins (NIM) as UK inflation and interest rates fall. The NIM is the difference between the loan interest received and the deposit interest paid. Another risk is legal action for mis-selling car loans through its Black Horse insurance operation.

The main risk in Aviva is that inflation in its key markets picks up again, so increasing the cost of living. This could deter new customer business and prompt existing clients to cancel their policies.

A clear win for Aviva here, in my view.

Relative undervaluation

The chances of dividend gains being wiped out by a sustained share price fall are reduced if the company is undervalued, in my experience.

On the key price-to-earnings (P/E) share valuation measurement, Lloyds now trades at 7.7, following a recent price rise.

This is the highest in its peer group, which averages 7.1, so it looks overvalued on that measure.

Conversely, Aviva currently trades at a P/E of just 12.3, against its peer group average of 18.9. So, it looks very undervalued on this metric.

Indeed, a discounted cash flow analysis shows it to be around 42% undervalued at its present £4.85 level. Therefore, the fair value of the shares would be £8.36, although that does not guarantee they will reach that price.

Another big win for Aviva, I think.

Passive income potential

In 2023, Lloyds paid a total dividend of 2.76p a share, giving a current yield of 5%. Aviva paid out 33.4p, providing a present payout of 6.9%.

This may not seem a massive difference. However, it is huge in hard cash terms over time if the dividends are reinvested back into the shares.

On this basis, £10,000 invested in Lloyds at 5% would make an additional £6,289 after 10 years.

If it had been invested in Aviva at 6.9% it would have made an extra £9,488.

After 30 years on the same provisos, the Lloyds investment would be worth £43,219. This would pay £2,161 a year, or £180 a month.

But the Aviva investment would be valued at £74,017! This would generate £5,107 a year in dividend payments, or £426 each month.

Three wins out of three for Aviva, in my opinion, underlining the benefit of my swapping some Lloyds shares for Aviva ones.

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.

Simon Watkins has positions in Aviva Plc. The Motley Fool UK has recommended Lloyds Banking Group Plc. 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.

More on Investing Articles

Investing Articles

I reckon these 2 penny shares are hidden gems worth a closer look!

Some penny shares are well-known, whereas many others go under the radar, but that doesn’t necessarily mean they aren’t potentially…

Read more »

Investing Articles

Just released: our 3 best dividend-focused stocks to buy before August [PREMIUM PICKS]

Our goal here is to highlight some of our past recommendations that we think are of particular interest today, due…

Read more »

Investing Articles

2 FTSE 100 shares with blockbuster yields investors should consider buying

Our writer has noticed that these FTSE 100 shares offer mammoth dividend yields, and reckons investors should take a closer…

Read more »

Stack of British pound coins falling on list of share prices
Investing Articles

Down 36% and yielding 7.8%, is this FTSE 250 share a bargain?

Christopher Ruane looks at a FTSE 250 share with a sizeable dividend yield and a recent record of dividend growth.…

Read more »

Investing Articles

Is Barclays one of the FTSE 100’s best bargain stocks?

Right now, Barclays' shares are cheaper than those of FTSE 100 rival stocks Lloyds and NatWest. So should I buy…

Read more »

Happy young female stock-picker in a cafe
Investing Articles

Is a takeover offer about to boost the Rentokil stock price, and should I buy?

The Rentokil share price is up 10% on takeover rumours. Is it a stock to buy or one to be…

Read more »

Investing Articles

Here’s my Rolls-Royce dividend forecast for 2024-27!

Our writer considers whether the Rolls-Royce dividend might be reinstated in coming years, based on financial performance and stated payout…

Read more »

Investing Articles

What would I do if Rolls-Royce shares plunged 50%? History suggests a big decline is coming

While Rolls-Royce shares have delivered massive outperformance in recent years, they also have a history of significant declines.

Read more »