1 dividend star that I would choose over Lloyds shares without hesitation

The main reason why I Lloyds (LSE: LLOY) shares lately is that they are trading like penny stocks. Strictly speaking, they are not because their market capitalization is too large.

However, each cent represents about 2% of the share value and therefore the risk is simply too great for me.

I used the proceeds to increase my holdings in several other stocks. All of these have a much higher dividend yield than Lloyds, better business prospects and appear to be more undervalued. One of these was the insurance and investment firm Aviva (LSE: AV).

Business outlook

Rising earnings and profits are the reason why a company’s dividends and stock price increase over time.

Analysts’ consensus estimates are for Lloyds’ earnings and revenue to grow 4.8% and 3.2% annually, respectively, through the end of 2027.

Aviva’s profits and revenues are expected to grow by 8.4% and 5.4% annually respectively by the end of 2027.

Lloyds also seems riskier to me, even if you ignore the greater price volatility.

The company is facing declining net interest margins (NIM) as inflation and interest rates fall in the UK. NIM is the difference between interest received on loans and interest paid on deposits. Another risk is legal action over the fraudulent sale of car loans by insurance company Black Horse.

The main risk for Aviva is that inflation in its key markets increases, raising the cost of living. This could affect new business and cause existing customers to cancel their policies.

In my opinion, this is a clear victory for Aviva.

Relative undervaluation

In my experience, the likelihood of dividend gains being wiped out by a sustained decline in share price is lower if the company is undervalued.

On the key price-to-earnings (P/E) ratio of stock valuation, Lloyds is currently trading at 7.7 after a recent price increase.

This is the highest score in the peer group, which averages 7.1. Therefore, the company appears to be overvalued by this measure.

Aviva, on the other hand, is currently trading at a P/E ratio of just 12.3, while the average of its peer group is 18.9. In this respect, the stock appears to be significantly undervalued.

In fact, a discounted cash flow analysis shows that the stock is undervalued by around 42% at its current level of £4.85. The fair value of the shares would therefore be £8.36, although that is no guarantee that they will reach that price.

Another big win for Aviva, I think.

Passive income potential

In 2023, Lloyds paid a total dividend of 2.76 pence per share, giving a current yield of 5%. Aviva paid 33.4 pence, giving a current yield of 6.9%.

This may not seem like a huge difference, but in cash terms it is huge over time when dividends are reinvested back into the stocks.

The story continues

On this basis, £10,000 invested at 5% with Lloyds would return an additional £6,289 after 10 years.

If it had been invested in Aviva at 6.9%, it would have earned an additional £9,488.

Under the same conditions, the Lloyds investment would be worth £43,219 after 30 years. This would yield £2,161 per year, or £180 per month.

However, the Aviva investment would be worth £74,017! This would generate £5,107 in dividend payments per year, or £426 per month.

In my opinion, three out of three wins are for Aviva, which underlines the advantage I gained by swapping some Lloyds shares for Aviva shares.

The post 1 Dividend Star I’d Have No Hesitation Buying Over Lloyds Shares appeared first on The Motley Fool UK.

Further reading

Simon Watkins holds positions in Aviva Plc. The Motley Fool UK has recommended Lloyds Banking Group Plc. The views expressed on companies mentioned in this article are those of the author and may therefore 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.

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