City bank names favourite dividend stocks with yields of 8-10%

There are plenty of big dividend yields available to income seekers, but some are better than others, according to this expert.  

Income stock Aviva (LSE:AV.) was today favoured over Legal & General (LSE:LGEN) after a City bank’s review of the European insurance sector focused on its significant pipeline of capital returns.

UBS boosted its target on Aviva shares by 10% to 489.5p, which compares with today’s 417.6p and the peak of 467.7p seen after better-than-expected results earlier this month.

Aviva trades with a 8.5% forward 2023 dividend yield, with shareholders due to receive their latest award of 10.3p a share worth £289 million on 28 September.

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Management has already indicated a potential share buyback announcement alongside annual results in March, which based on City expectations for a figure of around £250 million will take Aviva's total capital return yield to a chunky 10.6%.

UBS predicted the return of about 30% of Aviva’s current market capitalisation up to 2024, with the potential for an increase in the annual buyback to £350 million from 2025 if interest rates remain high and the return on investments into the business materialise.

The bank also likes savings and investment business M&G, which it expects to deliver about 40% of its market value in capital returns over the next three years.

Shares have fallen from 222p in mid-August to 196.3p but UBS sees 280p as its base case after upgrading its price target by 9.8% today. It adds that this could reach as high as 335p or £8.7 billion should M&G (LSE:MNG) become the subject of takeover interest.

The stock trades with a 10.2% forward dividend yield but with forecasts for £200 million a year of recurring share buybacks from 2022, the capital return yield increases to 14.4%.

Debt leverage poses a constraint to excess capital returns, but UBS believes an early £300 million debt tender in the second half of 2022 has the potential to offset these concerns.

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It notes that M&G and Aviva are exposed to inflation risks through their asset management and general insurance businesses, respectively, but believes these are manageable.

UBS adds that Aviva’s diverse earnings sources in life and non-life insurance are a competitive advantage, such as the positive benefit of higher interest rates for bulk annuity new business.

The bank adds: “We see Aviva's diversification as a key differentiator in the current uncertain market environment, allowing Aviva to grow in profitable business lines while reducing exposure to less profitable lines.”

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In contrast, UBS has a “sell” recommendation and price target of 240p on Legal & General, which compares with 253p seen today.

It points to the company’s greater sensitivity to credit and recessionary risk, arguing that a 2023 dividend yield of 8% is insufficient to offset these balance sheet worries.

However, the normalisation of market conditions and delivery on capital generation in excess of dividend expectations present potential catalysts for the shares. High interest rates are also a tailwind for UK annuity writers, with L&G the greatest beneficiary.