Image source: Getty Images
The FTSE 100’s Aviva (LSE: AV) has generated a sizeable dividend income since I bought it around three years ago. The financial services star paid a total dividend of 35.7p last year, giving a 5.7% yield on the current £6.25 share price.
It is worth noting however, that the yield has been significantly higher in the past. This is because the share price has surged recently, and the yield moves in the opposite direction, given the same annual dividend.
That said, consensus analysts’ forecasts are that its dividend will increase to 38.1p this year, 41p next year, and 44.4p in 2027. These would generate respective dividend yields of 6.1%, 6.5%, and 7.1% on the present share price.
How much passive income could be made?
The average UK savings amount is £11,000. So using the current 5.7% yield, this would make £8,425 in dividends after 10 years. After 30 years on the same basis, this would rise to £49,573. Adding in £11,000 initial investment and the holding would be worth £60,573. This would give an annual passive income of £3,453 by that time. This is based on the dividends being reinvested back into the stock – known as dividend compounding.
However, if the analysts’ forecasts are correct and the dividend yield rises to 7.1% much more could be made. Using dividend compounding again, on a 7.1% yield after 10 years they would be worth £11,327. And after 30 years they would be £80,984.
With the £11,000 stake added once more, the total value of the holding would be £91,984. That would generate a yearly passive income of £6,531 by that stage.
What about the undervaluation?
A share’s price does not necessarily reflect its value. The former is what the market will pay, and the latter reflects the fundamental worth of the firm.
Being able to identify the gap is a key to making big, consistent profits over time, in my experience. This includes several years as head of sales and/or trading for various investment banks and decades as a private investor.
The best way I have found to identify that gap is through the discounted cash flow (DCF) model. This pinpoints where any firm’s share price should be, based on cash flow forecasts for the underlying business.
In Aviva’s case, the DCF shows its shares are 39.7% undervalued at their current £6.25 price. Therefore, their fair value is £10.36.
Will I buy the stock?
Neither a high yield nor an undervalued price is sufficient for me to buy a stock. For this to happen, the firm also needs to have strong earnings growth prospects. It is ultimately these that will drive its share price and dividends higher over the long term.
A risk for Aviva’s is the high degree of competition in its sector that may squeeze its margins. However, consensus analysts’ forecasts are that its earnings will increase every year by 16.5% to the end of 2027.
This is the final part of the jigsaw for me, and I will buy more of the stock very soon.
