Insurance company Aviva (LSE:AV) looks like a potential bargain at the moment. The price-to-earnings (P/E) ratio of Aviva shares is just 9.
When I see a blue-chip company that has a P/E ratio in the single digits, it can grab my attention. But that's just one valuation metric, so as an investor, it's important to take a comprehensive view of a company's valuation.
Earnings are inconsistent
To begin with, what is that P/E ratio based on?
Last year, Aviva's core earnings per share was 37.7p. But the year before, the company posted negative core earnings per share of -34.7p. The previous year had been positive, but at 5.85p, it was well below what was achieved last year. Clearly, earnings at Aviva can vary significantly, meaning the P/E ratio may be a less useful valuation tool here than for other companies.
As an insurance company, differences in technical results from year to year can affect profits. For example, there could be an unusually damaging storm. Additionally, changes in the value of investments held by an insurance company can also affect profitability in a given year.
However, in the long term I am optimistic about Aviva's business prospects. Demand for insurance is likely to remain high, its brands are well known, it has a customer base approaching 20 million (almost 5 million British customers have multiple policies with the company) and a greater focus on markets major business in recent years has helped streamline the previously expanding business.
There are many things I like, but also some risks.
The business is still unwieldy, but it is a powerful money-making machine. In the first half of this year, for example, it made an operating profit of £875m. General insurance premiums in the six-month period exceeded £6bn.
Aviva cut its dividend a few years ago, but has since raised it again.
The provisional payment grew by 7%. The dividend yield now stands at 7.4%, which for a leading company FTSE 100 Businesses like this seem attractive to me.
However, insurance is a difficult business and there are always risks, as rivals Direct LineThe very heterogeneous performance of recent years has demonstrated this.
Premium pricing has changed a lot in the UK and Ireland in recent years. This has benefited subscribers, but I also see room for a move in a downward direction if a company tries to win business by competing more aggressively on price. Given the importance of the UK market to Aviva's overall performance, I see it as a risk for the company.
But I think investors should consider acting on Aviva's current share price. I think it represents good value for a company with a long history of growth, a proven business model, generous dividends and a focused business strategy.
