The insurance sector has always been a favourite of mine, despite its cyclical nature. If you’re good at timing (which I’m not), maybe you can dip in and out between cycles, but I think a more realistic strategy is buy and hold for a couple of decades. That way, I reckon you can build up a decent overall dividend income.
I currently have a stake in Aviva (LSE: AV). Although fundamental valuations make the shares look like a screaming bargain, I have to say I’m a bit twitchy when the market values a stock I hold on a very low P/E multiple. Based on full-year forecasts, Aviva is currently on a forward P/E of 6.5, which is less than half the FTSE 100‘s long-term average.
That’s come about from a collapse in the share price in the second half of the year, and Aviva is now down 27% year-to-date. The effect on the dividend yield is also remarkable, pushing it up to 8.2% on 2018 expectations, and 9.1% on 2019 forecasts.
Why are Aviva shares so cheap? Kevin Godbold has been pondering the same question, and he sees fears of the current cyclical insurance upswing breaking, together with market fears feeding upon themselves — if investors fear a share price crash, they’ll sell and increase the chances of a crash.
I don’t see that it can be just fears of a sector downturn, as others are still on higher valuations. Take RSA Insurance Group (LSE: RSA), whose share price has also fallen in 2018, but not as far. RSA shares have lost 20% of their valuation, but they’re still on a 2018 P/E level of 12.8, dropping to 9.9 on 2019 forecasts — comfortably ahead of Aviva, but I think still in bargain territory.
Forecasts for RSA suggest dividend yields of 4.5% and 5.9% for this year and next, so they’ve not been pushed to worryingly high levels.
Over five years, RSA shares have kept ahead of the Footsie too, gaining 21.5% against the index’s 2% drop. Aviva shares have performed badly over the same time, losing 17% of their value.
But if there’s something specifically wrong with Aviva, I really can’t see what it is. Aviva was one of the hardest hit by the financial crisis, and I do agree with Kevin that there’s definitely cause for concern over the current downturn.
One possibility is that Aviva didn’t manage to get in a few years of stable post-recovery progress before the latest Brexit-led economic clouds started to gather. And fears that the company might once again crumble are keeping sentiment firmly bearish.
There’s likely to be a lack of confidence in the dividend too, and I wonder if the company has been raising it a bit too fast. Having said that, Aviva’s dividend will have approximately doubled between 2013 and 2018, while RSA’s will have actually risen slightly more than that — and the bears are not out in the same force over RSA.
Out of favour
It looks to me as if insurance shares in general, and Aviva in particular, are priced for a massive economic meltdown, the likes of which would compete for effect with the banking crisis. But, whichever way Brexit eventually goes, I just don’t see that.
So I’m holding my Aviva shares, and I’d consider buying RSA Insurance too.
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Alan Oscroft owns shares of Aviva. 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.