Everybody likes a juicy yield, especially in today's low interest rate world, but you don't want overpay for the privilege. Are the following two income streams worth it, given their relatively high valuations?
I'm a believer
Insurance company Aviva(LSE: AV) is a strange stock to analyse. Currently, it yields a generous 4.7%, but income seekers must be prepared to meet a toppy valuation of nearly 19.7 times earnings. This is surprisingly expensive, given recent mixed growth. Aviva remains a company on the mend, with chief executive Mark Wilson working hard to turn around past under-performance, and markets seem to think he hasn't quite got there yet.
I think markets are being a bit harsh, given that Aviva recently announced a 13% increase in first-half operating profits to £1.3bn and hiked the interim dividend 10% to 7.42p per share. Its future looks even brighter, with earnings per share (EPS) forecast to rise a whopping 92% this year, followed by a further 12% in 2017. This reduces the forecast valuation to just 9.1 times earnings, which suddenly doesn't look expensive at all. The yield is also forecast to rise to 5.2% and, better still, today's wafer thin cover of 1.1 is expected to swell to a more secure 1.9, making the dividend look more sustainable.
Wilson is building a leaner, meaner insurer, one that is underpinned by a healthy Solvency II ratio of 174%. Aviva has also recovered strongly from its post-Brexit swoon and integrated Friends Life with aplomb. The headline numbers make Aviva look expensive, but closer examination suggests that it is a price worth paying. I'm a believer in Aviva.
Rival insurer Standard Life(LSE: SL) combines an even more seductive yield of 5.2% with a yet more breath-taking valuation of 25.7 times earnings. This is clearly a high maintenance, high reward stock. Yet it's not consistently rewarding, with the share price down 10% over the last year. Like Aviva, Standard Life has picked itself up from the pieces of the EU referendum wreckage. It has been boosted by the general burst of improved Brexit sentiment and warmly-received first-half results, showing an 18% rise in operating profits before tax to £341m, and a 10% leap in underlying cash generation to £254m.
Investors also enjoyed a generous dividend uplift, rising 7.5% to 6.47p per share. Its Group Solvency II ratio is lower than Aviva's at 154%, but with surplus capital of £2.2bn investors won't be too concerned.
The closer I look at Standard Life, the more it looks like Aviva. EPS are also forecast to grow 92% this year, slashing the forecast valuation to just 12.8 times earnings. Another 10% EPS growth is set to follow in September. Dividend cover is also set to pick up, from today's worryingly low 0.7 times to a rather more robust 1.3.
By the end of next year, dividend income is set to roll in at a rate of 6.2%. Standard Life is also exporting its fund management operation to emerging markets, which should offer long-term growth prospects as well. It is setting standards, so don't allow today's apparently costly valuation distract you from that fact. The price is right.
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Harvey Jones owns shares of Aviva. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.