Aviva (LSE: AV.) shares have fallen around 9% in little more than a month. That’s hard to square with a business that’s just delivered a 24% jump in operating profit and raised its dividend 7%.
So what’s going on? Should investors be worried about rising bond yields and the stock’s elevated multiple or has this pullback created an opportunity for long-term investors?
Rising bond yields
One reason I’m watching the shares closely is due to the sharp rise in government debt. Aviva has more than £25bn of shareholder assets invested in such debt alone.
There’s a twist though. Higher yields can ultimately be good for insurers because new money can be invested at more attractive rates. But when yields rise quickly, the market value of bonds already on the balance sheet falls.
That makes the company’s Solvency II ratio particularly important. A weaker capital position could restrict the amount of cash that can ultimately be remitted to the group for shareholder returns.
So I can understand why investors might be taking some money off the table after Aviva’s strong run. But with the underlying business continuing to perform well, I’m unconvinced rising yields alone are enough to change my view.
The bigger picture
While the market’s focusing on the risks at the moment, I’m more interested in what management’s guiding for over the next three years. Aviva’s targeting £7bn of cumulative cash remittances between 2026 and 2028. It’s also aiming for an IFRS return on equity of more than 20% and operating earnings-per-share growth of 11% a year.
These targets aren’t simply pulled from thin air. The insurer has a track record of delivering against its previous targets, which gives me some confidence in its ability to deliver this next phase of growth.
More importantly, I can see where that growth could come from. By 2028, it expects more than 75% of its operating profit to come from capital-light businesses. The integration of Direct Line is already moving ahead at pace. Costs are being removed and written margins have improved. The business is also returning to policy growth through price comparison websites in motor insurance.
A diversified growth engine
And it’s not just general insurance that’s moving forward. Aviva’s Wealth business is growing too. There are almost £3trn of assets in the UK wealth market today, and the market’s growing at double-digit rates. Aviva’s already the number-one player, with £261bn of assets under management.
What’s particularly interesting to me is the opportunity to cross-sell Wealth products to its existing customer base. With more than 21m UK customers, and millions holding multiple policies, Aviva has a potentially powerful growth engine on its doorstep.
The valuation’s another matter. On a headline basis, the shares trade on a price-to-earnings ratio of 38.8. But on an adjusted earnings basis, that falls to 11.5. That’s a sizeable difference and suggests the headline multiple doesn’t tell the whole story.
For potential new investors, the shares could have further to fall, particularly if the wider market remains under pressure. But if Aviva can deliver its ambitious targets, I think the longer-term growth opportunity remains attractive. That’s why I still see the shares as worth considering.
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Andrew Mackie owns shares in Aviva.
This story originally appeared on Motley Fool
