How to Safely Pick Up High-Yield Dividends From British Stocks

The British pound trades at an all-time low against the U.S. dollar. Today, an American needs to scrape together only $1.23 to buy one pound. This time last year the same pound cost $1.55. As recently as 2007, a pound owner would demand $2.10 for his cherished possession.
The depreciated British pound means Americans can buy more goods priced in pounds. But the shelves aren’t limited to goods. American investors can also buy more British stocks per dollar invested. Many British stocks that trade as American Depositary Receipts (ADRs) on U.S. stock exchanges are attractive to U.S. investors.
I find one British company more attractive than most. Aviva Plc (NYSE: AV) is one of Britain’s largest life insurers. As I write, Aviva stock yields over 5%.
The Aviva name is likely unfamiliar to U.S. investors, but anonymity need not be synonymous with insignificance. Aviva has plenty of girth and presence. It operates in 16 countries (the United States isn’t one of them), serves 33 million customers, and employs 29,600 people. Its market cap exceeds $22 billion; over the trailing 12 months, it generated $43.2 billion in revenue.
Girth is fine, as long as motion is maintained. Aviva remains in motion. It has a record of strong life insurance growth. The value of new life insurance business has grown at an average rate of 14.2% annually rate over the past four years.
Growth is fine, as long as it’s intelligent growth. Aviva grows intelligently. It invests its premium income primarily in debt securities; it owns $63 billion dollars’ worth. Roughly 75% of these securities are rated “A” or higher by the major rating agencies. As for Aviva’s own debt, it’s rated “A” or higher by the major rating agencies.
In short, Aviva is a growing insurance company with a rock-solid capital structure, though few investors seem to notice.

Aviva Stock Sell-Off

Immediately after the Brexit vote, Aviva shares sold off, as did most British shares. Both Aviva’s London-traded shares and its U.S.-traded ADRs were down as much as 30% (and the ADRs are still down 30% year to date).
The depressed ADR price, coupled with Aviva’s 5% dividend yield, offers an enticing value proposition. The likelihood of the pound appreciating vis-à-vis the dollar further enhances that proposition.
When the pound weakens against the dollar, the London shares perform better than the ADRs. But the coin is two-sided: When the pound strengthens against the dollar, the advantage shifts to the ADRs. If we go back a couple years, when the pound strengthened strongly against the dollar, the advantage shifted strongly to the ADRs.
So, with Aviva, both U.S.-based and British-based investors benefit from intelligent growth. Income investors on both sides of the Atlantic also benefit from Aviva’s commitment to dividend growth. Management plans to increase the dividend-payout ratio to 50% of operating earnings, up from 42% this year, and 37% the year before. If operating earnings were simply to hold steady, we’d see an increase in the dividend payment.
But operating earnings are unlikely to hold steady. Management expects operating earnings to grow at a mid-single-digit rate annually over the next three years. Aviva will pay a higher percentage of earnings to investors as dividends. At the same time, those earnings will rise. No better formula for dividend growth has been devised.
U.S.-based ADR holders could fare better in the dividend-growth game than their U.K brethren. ADR holders will receive an additional boost in dividend income when the pound shifts to appreciation from depreciation.

Good News for U.S. Investors

Here’s why: Aviva pays its dividends in pounds. As the pound appreciates it can buy more dollars, thus the dividend in dollars (for the ADRs) will rise at a higher rate than the dividend in pounds. An appreciating pound will buy more dollars to pay dollar-denominated dividends on the ADRs.
Yes, the pound could depreciate further against the dollar, but I see appreciation as the more likely scenario. (I’m not alone in my supposition. Many notable investors, including famed contrarian Wilbur Ross, have bought the pound.) A rising dividend-payout ratio, rising operating earnings, and a rising pound are all good news for U.S-based Aviva investors.
High returns are in the waiting. In the past, as little as a 10% increase in the British pound against the dollar has produced a 30%-to-50% increase in Aviva’s ADR price. It happened in 2014; it could happen again in 2017.