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Why fat dividends from Aviva plc leave me cold

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With its dividend yield running above 5%, life and general insurance company Aviva (LSE: AV) is bound to pop up on any big-company screen you run looking for high yield.

We dividend-focused investors tend to be a cautious lot, so the FTSE 100 company’s market capitalisation of around £21bn and its well-known name will no doubt provide reassurance. Meanwhile, trading has been good. Earnings shot up around 130% during 2007.

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Lack of share-price progress

Yet, if you’d bought some of the firm’s shares in the spring of 2014, you’d have paid something close to today’s price around 520p. The stock made no upward progress in four years, but revenue increased by more than 25%, earnings went up 59% and the directors pushed the dividend more than 80% higher.

Because of this lack of share-price progress, the valuation contracted. Aviva now pays a big dividend and earns bumper profits. That worries me. Modest valuations and cyclical businesses don’t add up to the usual value opportunity in my view, and that view has been broadly right for four years with this one.

Despite no progress on capital gains for shareholders, there’s oodles of downside risk. In the words of one Fool, the firm had a near-death experience in the wake of the financial crisis, so what will the next economic downturn bring? I wouldn’t want to be holding the shares when we find out. I think we’ve had a glimpse recently of what can happen with cyclical outfits such as Aviva. In 2015 and 2016, the company posted earnings declines of 52% and 34% respectively and the share price moved down 30% between the spring of 2015 and the summer of 2016.

The dividends keep on coming

Does that kind of volatility matter, though? After all, Aviva didn’t miss a beat with its dividend payments even raising them in 2015 and 2016. I think it does because big moves in the share price mean that capital losses can wipe out years of dividend income gains for investors. What if profits, the dividend and the share price have all hit a cyclical low at the time you want to retire and draw on your investment funds? Your funds may no longer be there to take. Sometimes, cyclical firms can crash so hard into a cyclical low they never fully recover. Just look at the big UK banks for evidence of that.

Looking forward, Aviva’s earnings are set to grow more than 60% in 2018 and around 8% in 2019, but I’m not expecting the share price to go up much. The stock market got the measure of cyclicality long ago and I think it will mark down Aviva’s valuation all the more the higher profits go, in anticipation of the next cyclical plunge in earnings.

And if Aviva ever becomes a ‘square’ share – where the figure for the dividend yield equals the figure for the P/E ratio – look out below. Again, look at the big banks leading up to the credit crunch for inspiration over that issue! Fat dividends from Aviva leave me cold and I’m looking elsewhere for my buy-and-hold dividend and growth investments.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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