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Why Is Aviva plc So Cheap?

AvivaBack in 2011 when insurance giant Aviva (LSE: AV) (NYSE: AV.US) was paying dividends way in excess of earnings, you would have had every right to be worried — especially if you owned the shares.

The whole insurance sector was going through a few bad years during the credit crunch, and those paying poorly-covered dividends were starting to look shaky. Some hoped we’d see a quick recovery with no need to slash the cash — but it was a naive hope.

Crunch

And then the inevitable happened — Aviva was forced to cut its dividend halfway through 2012, and from a 26p-per-share payout in 2011, the annual cash bonanza dropped to 19p in 2012 and to 15p by 2013.

Aviva had been badly overstretched and its shares overpriced, and the share price collapsed as a result and spent a couple of years wallowing around the nether regions of the FTSE.

But what about now?

Well, after the rebasing of the dividend and a bit of time going nowhere, the share price is on the up again. Over the past 12 months we’ve seen a rise of 53% to 514p, compared to the FTSE’s 10%. (And I’m pleased I added Aviva to the Fool’s Beginners Portfolio in March 2013 — we’re up about 60% since then.)

But I reckon Aviva shares are still cheap.

Bullish forecasts

The thing is, we have a very strong recovery from the recent slump forecast, and that puts Aviva shares on a forward P/E of only 11 — the FTSE long-term average is approximately 14, and Aviva shares were on a trailing P/E as high as 27 at the end of 2011!

Beyond this year, we have further rises in earnings per share (EPS) predicted, dropping the P/E to only 10 based on 2015 forecasts.

And the dividend is growing again, from its reduced level — for this year there’s a 3.2% yield expected, with 3.7% indicated for next year.

What’s more, that cash should be around 2.8 times covered by earnings — so it’s looking safe.

Stability

At first quarter time, chief executive Mark Wilson told us that “Aviva’s overall performance in the first quarter was reassuringly calm and stable” — and those those are words that should sound wonderful to the ear of anyone who invests in the insurance sector. Calm and stable. Ahhhh.

So why are the shares so cheap?

I really don’t know, but I’m convinced they are — and a majority of City analysts agree with me, with a 13 to 4 majority urging us to Buy.

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Alan does not own any shares in Aviva or Tesco. The Motley Fool owns shares in Tesco.