The FTSE 100’s life insurance giant Aviva (LSE: AV) looks tempting against traditional valuation measures. The current share price of around 419p throws up a price-to-earnings rating of just over seven, a price-to-book ratio of around one, and a dividend yield of more than 7% — cheap, cheap, cheap!
But if you look at the six-year financial record, you’ll see that revenue, earnings and operating cash flow have all been patchy over the period, rising up and down from year to year. Meanwhile, the dividend has been on a steady upwards trajectory. In fairness, City analysts expect advances in revenue and earnings during 2019.
Some ongoing risks
The quality indicators don’t look so appealing with the operating margin running close to six and the return-on-capital and equity figures in low single-digit percentages. And the share price has moved essentially sideways for five years with some big swings up and down along the way. During that period, the valuation seems to have been compressing. Welcome to the world of cyclical shares and their sometimes-odd-looking behaviour.
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Today’s full-year results reveal that Aviva earned around 78% of its operating profit from its life insurance business in 2018, 18% from general and health insurance, and 4% from fund management. My guess is that life insurance could be easier for people to forego in tough economic times than other types of insurance such as for cars and homes, which is why I reckon the firm’s trading outcome is vulnerable to general economic cycles.
Around 81% of that operating profit came from the home UK market, which lends the firm a lot of single-country risks. It could be that the ongoing Brexit process with all its uncertainty is holding the shares back, but I’m not so sure about that. Maybe the market thinks the valuation deserves to be low anyway, just because there’s no telling when the next cyclical plunge will arrive.
A change in dividend policy
Today’s figures are positive with operating profit 2% higher than the year before and earnings per share 9% higher. The directors seem confident in the outlook and pushed up the total dividend for the year by more than 9%.
However, the news on dividends may not be as good going forward. Chief financial officer Thomas D Stoddard said in the report the firm has decided to ditch the previous policy of tying the dividend to operating earnings per share. The idea is that the new chief executive, Maurice Tulloch, will have “greater flexibility to implement his strategic agenda.”
Remember that patchy financial record I mentioned earlier? The implications could be even more volatility ahead in total returns for investors. Although it’s unclear how much difference the change will make, the potential is there for it to be a big difference.
That said, the new man at the top said in the report that Aviva is only “scratching the surface” of its potential, and the firm seems determined to at least maintain the level of dividend payments. But I’d rather mitigate the risks with Aviva by avoiding the shares.
