Opportunity Or Threat? Are Aviva plc’s Gains Good News For Investors?

Looking at the chart of Aviva (LSE: AV) (NYSE: AV.US) alongside the FTSE 100 gives you a perfect illustration of how avivadifferent stock prices respond to variations in investment environments — for when it comes to how bull markets impact companies’ valuations, a rising tide does not lift all boats equally.

In the past year, Aviva is up an impressive 31% versus a more sober 5.1% across the board. But over the previous five-year period, Aviva is still trailing the index by around a third. For a long time, Aviva lagged the FTSE heavily: indeed, up until this time last year, investors were still out of pocket on a five-year basis.

Some analysts have pointed out lately that investors are getting too greedy for companies targeting aggressive growth, and chief among such companies is Aviva. These investors are at risk of losing money in the overhyping of the stock price, they maintain. I disagree, since that type of thinking ignores perhaps the most fundamental picture of market activity: the curve.

Curvy Is Better

The key to understanding the diverging charts between the index as a whole and Aviva specifically is to see that in stock markets prices and the earnings on which they are based multiply on an exponent basis. The bigger the exponent and ‘curvier’ the growth trajectory, the bigger the gains. 

As an insurance and asset management provider, Aviva does well in markets where people are spending and investing: after all, you only insure everything in the house or invest in asset management funds when you can pay the mortgage first.

But recently, that’s been the case for many around the world, so Aviva’s earnings are soaring. The company made £35.1bn of sales in the first six months of 2014, a comparative increase of 60% over the same 12-month ago period. But the sales got easier to make, too, meaning lower costs. The additional sales and lower overhead combined is what makes for the exponent ratio of growth in earnings, so Aviva’s H1 ’14 profit of £938m showed a 45% increase over the same period last year and is still climbing when you consider it’s also on target to chop an additional 6.9% of its operating expenses.

Of course, many companies right now are reporting big revenue increases, but they are also reporting cost increases. That’s a completely different song to the one Aviva is singing, since in that case there is a significantly lower exponent driving the growth multiple of the bottom line.

With this in mind, Aviva’s current P/E of 24 looks much cheaper than the market as a whole on a forward basis, since it appears investors are still discounting the exponent multiple in Aviva’s earnings, to the extent the stock may double in value over the next year from here if things remain on track.

Harnessing The Exponent 

That might seem a big call, given that Aviva has a market capitalisation of £15 billion already, but exponent multiples when stretched out over time frequently lead to gains that way outstrip returns in comparative investments. 

That's why investment cases involving turnaround stories like this one stand to yield such outsize gains, since the earnings and the growth are simultaneously driven by exponential changes at the company's operating level. Motley Fool's 3 Shares To Beat Property are born out of the same principle, too.

To get a practical grip understanding on how to parlay this and other skills into picking your own winners, read this free Foolish report now on 10 steps you can apply to making a million from your own investment in the market.

Daniel Mark Harrison has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.