Which is the better dividend stock: Aviva plc or Legal & General Group plc?
At the end of November, insurance group Aviva(LSE: AV) made headlines when it increased its growth targets and dividend promises for the years ahead, signalling the end of a multi-year turnaround.
At an investor meeting, chief executive Mark Wilson said that the insurer had "an embarrassment of riches," after slimming itself down and the group is now promising to deploy £3bn of excess cash in 2018 and 2019. City analysts had been expecting the company to announce a blowout £3bn buyback, but instead, Wilson and team are planning to use the extra cash to pay down expensive debt and invest in new growth initiatives.
Growth and cash
Shareholders might have preferred to receive the money, but strengthening the balance sheet and investing for the future is a better policy in my view. The group will pay down around £900m of debt (plus $650m this year), saving an estimated £100m a year in interest leaving £2.1bn to invest in growth. Some cash has already been splashed on robo advice company Wealthify, and EUR130m has been spent acquiring Irish insurer Friends First.
These efforts to strengthen Aviva's balance sheet, and invest in growth should underpin cash distribution growth in the years ahead. Management has increased its dividend target from 50% of earnings to 55%-60%.
According to City analysts, the firm's new slimline business, coupled with its higher payout ratio means that dividends should grow by more than 10% per annum from 2018. Based on current estimates the shares will yield 28.7p for 2018, giving a dividend yield of approximately 5.6%. As well as this market-beating distribution, the stock trades at a forward P/E of under 10.
The better buy for income?
Compared to Aviva, Legal & General (LSE: LGEN) looks expensive. The shares trade at a P/E of more than 10. However, when it comes to income, Legal is the better choice. The shares are set to support a dividend yield of more than 6% for 2018.
At the beginning of the year, Legal announced that it was on track for a "record year" thanks to a boom in demand for its retirement products. The firm has generated around £3.3bn of UK bulk annuity sales so far in 2017 and doubled US bulk sales to $0.7bn. Meanwhile, the group's investment business attracted £38bn of net fund inflows during the period while insurance premiums rose at a double-digit rate.
The choice between growth and income
Like Aviva, Legal is trying to expand into new markets. For example, management is weighing further expansion into the US as well as additional growth in existing lines of business.
Still, when it comes to growth and income, I believe that Aviva is the better option.
Legal might be more prominent, and offer a more substantial dividend yield, but Aviva's tech investments are forward-thinking. A joint venture with Chinese e-commerce company Tencent and private equity firm Hillhouse Capital in Hong Kong should help the now cash-rich group continue to expand while returning cash to investors at the same time.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.