Looking at the annual payment to the insurer's shareholders Aviva (LSE: AV), I like what I see. Right now, Aviva's dividend yield is 7%.
I think it could go higher from here. So should you invest?
Promising dividend prospects
Let me start by explaining why I'm optimistic about what could happen with the payment. After all, it's only been a few years since we saw a dividend cut from Aviva (a reminder that no payout is ever guaranteed to last).
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As far as I'm concerned, there are a couple of ways this could be viewed.
One is to say that insurance is a cyclical business: rates go up and subscribers do well, but at some point they fall again across the industry and profits decline.
Another analysis is that Aviva has historically been a different set of businesses, but under current management it has become more focused and placed its dividend on a more sustainable footing than before.
Which of these is truer (since both can be valid), only time will tell. But I think there are many positives in the insurer's business prospects, from its large customer base, its strong position in the UK market and its brand to its proven underwriting capabilities.
The dividend grew 7.7% last year. The yield is already 7%. Therefore, if the dividend growth rate can continue at its current level, the expected return a couple of years from now will be 8% and five years from now, the expected return will be 8%. FTSE 100 The stock will yield a juicy 9%.
Balancing risks and rewards
I find the company's current management competent and realistic, so for Aviva's dividend to continue growing at a strong pace, business performance will need to support it.
Often when analyzing the sustainability of a dividend, I look at a company's free cash flow.
Can this help in this case? Look at the graph.
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Like many financial services companies (especially insurance companies), free cash flow doesn't help me as much as it could. It reflects money coming in and out that doesn't necessarily illustrate the underlying health of the company.
So I pay more attention to how much surplus capital Aviva generates, since it can use that to help fund its dividend.
In this sense, I think things look promising. In its annual results last year, the company announced a share buyback. It also announced that the cash cost of its dividend will continue to grow at a mid-single-digit rate each year. That could be, for example, 5%, but since the buyback reduces the number of shares, that could mean greater per-share growth in the payout.
If I had extra cash to invest, the potential for a growing dividend from Aviva would make me want to add this income stock to my portfolio.
