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I’d buy this stock to generate passive income of 8.7% a year

Mature black couple enjoying shopping together in UK high street
Mature black couple enjoying shopping together in UK high street

I never stop being amazed by the number of top-quality FTSE 100 companies paying generous passive income via their dividends at the moment.

Some of these dividends are too generous and liable to be cut (I’m looking at you, Persimmon), but not all of them. Insurer Aviva (LSE: AV) tempts me right now.

I’m on the hunt for passive income

Currently, Aviva yields passive income of 8.7% a year, covered 1.5 times by earnings. That is solid cover, although not completely convincing. So will the company generate the cash flows it needs to keep shareholders happy?

CEO Amanda Blanc has done a good job since taking the helm in July 2020, when the share price stood at 273p. Today, it trades at 439p. Growth has slowed this year, unsurprisingly, but Aviva shares are still up 5.5% year to date. The FTSE 100 as a whole is down 1.90%.

Blanc has turned Aviva into a leaner, meaner operation, selling eight divisions for £7.5bn and returning £4.75bn to shareholders. Now it is focused solely on the UK, Ireland, and Canada, which should stop its attention wandering.

Last week, Aviva reported a 46% jump in new business across its UK and Ireland life division to £466m in Q3. General insurance premiums increased too, although other parts of the business grew at a slower speed or fell slightly.

Times are “challenging”, Aviva said, but it’s still on track to deliver it £750m savings target by the end of 2024. Better still, it expects to launch a new share buyback programme with its 2022 full-year results, subject to market conditions and regulatory approval.

If it can afford to launch a new share buyback, that suggests to me that the dividend must be pretty secure. In August, Aviva declared an interim dividend of 10.3p, in line with its full-year dividend guidance of roughly 31p. That also looks promising. As did Blanc’s bullish outlook, as she reported that “Sales are up, operating profit is higher, our financial position is stronger”.

Aviva shares look cheap, too

The dividend yield is forecast to dip to 7.1% next year, with cover shrinking slightly to 1.4. Again, I’m not too concerned, given the fundamentals. Aviva won’t cut the dividend unless absolutely necessary, and right now it faces few serious threats. The company still generates loads of cash.

Also, its Solvency II shareholder cover ratio stood at 223% in Q3, dipping only slightly by 11%. Surplus capital above a 180% cover ratio increased from £2.3bn to £2.5bn. It’s a solid operation.

What also attracts me is that Aviva’s shares look cheap right now, trading at 7.8 times earnings. That looks like an attractive entry point, although I accept the shares have looked cheap for years so there’s no guarantee they will increase in the near future.

I’m adding Aviva to my buy list watchlist but before I buy it, I also want to check out FTSE 100 rival Legal & General Group. That is another dividend aristocrat, yielding 7.51% and trading at just 7.20 times earnings. Remarkably similar to Aviva, as it happens. These are good times to be an investor hunting for passive income.

The post I’d buy this stock to generate passive income of 8.7% a year appeared first on The Motley Fool UK.

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Harvey Jones doesn't hold any of the shares mentioned in this article. 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.

Motley Fool UK 2022