It’s been a great year for investors in Aviva (LSE: AV), with the insurance company seeing its share price rise by 18% since the turn of the year. This is a much better performance than the FTSE 100, which is up just 2% year-to-date.
However, shares in Aviva could have more upside potential and may deliver a total return of 30%+. Here’s why.
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A New Strategy
Following the appointment of a new management team, Aviva has followed a completely different strategy than in the past. Indeed, the slashing of its dividend in March 2013 signalled the start of a major change for the business and how it operates. Since then, Aviva has successfully been able to reduce the size of the business through various disposals, which have helped to make the company much leaner and also moved the risk/reward ratio much more in its favour. Together with the efficiencies that have been made, this means that Aviva is on a much stronger financial footing moving forward.
Growth Potential
It’s not all that often that an insurance company is described as a ‘growth stock’. However, in Aviva’s case it is entirely warranted, since the company is forecast to increase its bottom line by an impressive 10% next year. This shows that the new strategy is starting to bear fruit and bodes well for the company’s longer term future. It also means that investor sentiment has been much stronger in recent months, as shown in the gains made by the company’s share price.
Looking Ahead
Despite its strong growth prospects, Aviva continues to trade at a relatively low price to earnings (P/E) ratio of just 10.4. This is well below the FTSE 100’s P/E of 13.9 and shows that there is considerable scope for an upwards adjustment to Aviva’s rating. However, the real potential for price increases could come from the company increasing its dividend payout ratio.
That’s because Aviva is set to only pay out 35% of this year’s net profit as a dividend. Considering the business is now on a much stronger financial footing, this seems rather low. Indeed, were Aviva to pay out 45% of profit as a dividend — and assuming shares in the company continue to yield their current 3.1% — it could mean that shares trade at a price of 680p.
This would represent a gain of 27.1% from their current price level and, with a respectable dividend yield of 3.1%, could mean that a total return of over 30% is realistic over the medium term.
