One of the attractions is purchasing shares in a proven company FTSE100 the business may be the potential for dividend income. Policyholder Aviva (LSE:AV) is an example. Aviva’s dividend yield is currently 7%.
Could it go up from here – and should I buy this share as part of my ISA?
An uneven dividend history
At first glance, the dividend history here seems sturdy. For several years, the amount of ordinary distributions to shareholders has been increasing year by year. For example, last year the dividend increased by 7%.
But as a long-term investor, I consider more than just the latest data whenever I can. Looking back over the last decade and more, we see that the dividend has been cut more than once.
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Dividends are never guaranteed in any company. The chart shows what this meant in practice. Aviva’s dividend growth has been high on more than one occasion, only for the payout to be cut later.
A transformed company with great prospects
However, just because something like this has happened before doesn’t mean it will happen again.
Over recent years, Aviva has significantly changed the shape of its business. He sold many operations, distributing part of the proceeds in the form of a special dividend (not shown in the chart above).
This allowed it to focus its energy on key markets such as the UK. It has a number of competitive advantages, including a enormous customer base, sturdy brands including Norwich Union and deep underwriting experience.
For now, however, the results may not be obvious in the context of the company’s profits. Basic earnings per share improved last year, but that followed a series of declines.
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Earnings are an accounting measure, so they don’t always provide the most useful information when it comes to valuing financial services companies. These can fluctuate significantly due to changes in the value of the assets the company holds on its books, which may have little to do with cash flow.
When it comes to Aviva’s dividend, cash flow matters because, ultimately, dividends are a way for a company to distribute excess cash.
Here again, the company’s performance changed significantly.
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What gives me confidence, however, is that Aviva has demonstrated that it can generate a significant cash surplus, even if this amount may fluctuate from year to year.
One measure of this is the so-called “generation of operating own funds according to Solvency II”. Last year it brought in £1.7 billion, up 12% on the previous year.
Future prospects look good
If Aviva can continue to generate surplus cash at a high level – which I think it is likely to do – then I would expect the dividend to grow in this case. The company says it expects the cash cost of the dividend to enhance, which if the number of shares stays the same means the payout per share should enhance. Aviva’s potential dividend yield would then be over 7%.
There are risks along the way. Poor insurance choices can unexpectedly hurt profits, as was the case with a rival Straight line last year. The company’s greater focus on the UK market also ties Aviva closer to the UK economy: a recession could make policyholders more price sensitive, negatively impacting policy renewal rates.
But the income prospects attract me. If I had free funds to invest, I would gladly buy Aviva shares.
