The main reason I sold my Lloyds (LSE: LLOY) shares recently is that they trade like a penny stock. They are not one strictly speaking, as their market capitalisation is too big.
Nonetheless, each penny represents around 2% of the share’s value, making the risk simply too great for me.
With the proceeds, I increased my holdings in several other shares. These all have a much higher dividend yield than Lloyds, a stronger business outlook, and appear more undervalued. One of these was insurance and investment firm Aviva (LSE: AV).
Business outlook
Rising earnings and profits are what drive a company’s dividends and share price higher over time.
Consensus analysts’ estimates are that Lloyds earnings and revenue will increase by 4.8% and 3.2% a year, respectively, to end-2027.
Aviva’s earnings and revenue are projected to rise, respectively, by 8.4% and 5.4% a year to the end of 2027.
Lloyds also looks riskier to me, even leaving aside its greater price volatility exposure.
It faces declining net interest margins (NIM) as UK inflation and interest rates fall. The NIM is the difference between the loan interest received and the deposit interest paid. Another risk is legal action for mis-selling car loans through its Black Horse insurance operation.
The main risk in Aviva is that inflation in its key markets picks up again, so increasing the cost of living. This could deter new customer business and prompt existing clients to cancel their policies.
A clear win for Aviva here, in my view.
Relative undervaluation
The chances of dividend gains being wiped out by a sustained share price fall are reduced if the company is undervalued, in my experience.
On the key price-to-earnings (P/E) share valuation measurement, Lloyds now trades at 7.7, following a recent price rise.
This is the highest in its peer group, which averages 7.1, so it looks overvalued on that measure.
Conversely, Aviva currently trades at a P/E of just 12.3, against its peer group average of 18.9. So, it looks very undervalued on this metric.
Indeed, a discounted cash flow analysis shows it to be around 42% undervalued at its present £4.85 level. Therefore, the fair value of the shares would be £8.36, although that does not guarantee they will reach that price.
Another big win for Aviva, I think.
Passive income potential
In 2023, Lloyds paid a total dividend of 2.76p a share, giving a current yield of 5%. Aviva paid out 33.4p, providing a present payout of 6.9%.
This may not seem a massive difference. However, it is huge in hard cash terms over time if the dividends are reinvested back into the shares.
On this basis, £10,000 invested in Lloyds at 5% would make an additional £6,289 after 10 years.
If it had been invested in Aviva at 6.9% it would have made an extra £9,488.
After 30 years on the same provisos, the Lloyds investment would be worth £43,219. This would pay £2,161 a year, or £180 a month.
But the Aviva investment would be valued at £74,017! This would generate £5,107 a year in dividend payments, or £426 each month.
Three wins out of three for Aviva, in my opinion, underlining the benefit of my swapping some Lloyds shares for Aviva ones.
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Simon Watkins has positions in Aviva Plc. The Motley Fool UK has recommended Lloyds Banking Group Plc. 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.
