2 bargain dividend stocks I'd buy now

Updated: 
Aviva head office

As a keen income investor, I'm always on the lookout for under-priced dividend stocks I can add to my portfolio. Today I'm going to look at two firms I believe could deliver significant gains over the next year.

This yield looks safe to me

Insurance group Aviva (LSE: AV) has risen by 30% from last July's post-referendum lows. But the shares still seem cautiously valued, on a 2016 forecast P/E of 10. In my view this worrisome outlook isn't justified by Aviva's performance during the first half of last year, when operating profit rose by 13% to £1,325m.

This increase was backed by a 6% rise in net asset value, and by 7% growth in the firm's life and general insurance businesses. Chief executive Mark Wilson has delivered on this promise to prioritise sustainable growth and cash flow since taking charge in 2013. As things stand, I don't see any reason to doubt that Aviva will make further progress in 2017.

Although the firm's payout has been cut several times over the last 15 years, dividend cover is expected to stay above two times earnings this year. Market forecasts currently suggest that Aviva's dividend could rise by 12% to 25.5p in 2017, giving a prospective yield of 5.2%.

Aviva is expected to report its 2016 earnings on 9 March. But with the shares trading on a 2017 P/E of just nine, I believe the shares may be cheap enough to justify buying ahead of these results.

Ex-bank boss delivers goods

Ex-Royal Bank of Scotland Group boss Stephen Hester was a surprise appointment as chief executive of RSA Insurance Group (LSE: RSA) in 2014. But Mr Hester has proved to be a successful choice.

RSA's earnings per share are expected to rise by 38% to 42.5p in 2017. If the group hits this forecast, it will mean a return to profit levels last seen before the firm's problems started in 2012.

Dividend payments are now rising fast as well. RSA's 2016 payout is expected to be 14.6p, a 40% increase on 2015. A similar hike is pencilled-in for 2017, giving a 2017 forecast yield of 3.5%.

My view is that RSA's turnaround may still have further to run. By buying at current prices, shareholders could benefit from price gains in 2017 and an above-average yield from 2018 onwards.

However, it's worth pointing out that City analysts have recently turned cooler on RSA. Consensus forecasts for 2016 earnings have been cut by 7% over the last three months, despite Mr Hester advising investors in November of an "attractive tailwind" from exchange rate changes.

One concern is that RSA's Solvency II capital ratio, a measure of how much spare capital RSA has over the minimum required, fell from 158% to 151% between June and September. This is significantly lower than a number of peers, including Aviva, which reported a solvency ratio of 174% in August.

In my view, RSA's lower solvency ratio is unlikely to signify serious problems. I believe the group's shares are a reasonable buy at current levels, but my top income pick in this sector remains Aviva.

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Roland Head Aviva and Royal Bank of Scotland Group. 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.