Aviva (LSE: AV) shares paid a total dividend in 2024 of 35.7p, giving a current yield of 5.4%. However, its interim dividend this year increased 10% from 11.9p to 13.1p. If this were applied to the entire dividend then this year’s payout would be 39.27p. On the current £6.61 share price, this would generate a dividend yield of 5.9%.
This is precisely the consensus analysts’ forecast, which then projects a dividend of 41.4p next year and 44.5p in 2027. These would give respective dividend yields of 6.3%, and 6.7% on the present share price.
This also aligns with Aviva’s aim of increasing shareholder returns when it can. This has included lifting dividends from 2021’s 22.05p to last year’s 35.7p – a jump of 62%.
What’s this mean for dividend income?
If I were to add another £10,000 investment to my existing Aviva holding, then I would make £540 in first-year dividends. Over 10 years on the same average yield this would rise to £5,400. And over 30 years on the same basis it would increase to £16,200.
This is certainly a much better return than I could make from the current FTSE 100 average dividend yield of 3.3%. It is also better than the ‘risk-free’ rate (10-year UK government bond) of 4.6%.
However, it could be even better by using the standard investment tool of ‘dividend compounding’.
The magic of dividend compounding
This method simply involves reinvesting the dividends paid by a stock straight back into it. It is like leaving interest to accrue in a bank savings account. By doing this – on the same £10,000 amount and 5.4% yield – the dividends would be £7,139, not £5,400. And after 30 years on the same basis, this would rise to £40,348, rather than £16,200.
Including my initial £10,000 investment, the total value of this new holding would be £50,348. And that would be paying me an annual dividend income by that time of £2,719!
What about share price gains?
I buy high-yielding dividend stocks for their annual income potential, but they often rise in price too. This is because I always select dividend stocks that also look very under-priced to their ‘fair value’. Value reflects the worth of the underlying business, while price is whatever the market will pay for a stock at any point.
I have found the best way to identify the price-value gap is through discounted cash flow (DCF) modelling. This pinpoints where any firm’s share price should trade, based on cash flow forecasts for the underlying business.
The DCF for Aviva shows its shares are 42% undervalued at their current £6.61 price. Therefore, their fair value is £11.40.
In my experience as a former senior investment bank trader, assets tend to converge to their fair value over time.
Will I buy more?
Earnings growth is the key to any stock’s price and dividend gains. A risk to Aviva’s is that intense competition in its sector may pressure its margins. However, consensus analysts’ forecasts are that its earnings will grow by a stellar 17.2% a year to end-2027.
Given this, and what this will likely mean for its undervalued share price and its dividend yield, I will buy more Aviva stock very soon.
