Aviva (LSE: AV) shares have dropped 7% since their 29 August 12-month traded high of £5.08.

Now at £4.73, the total dividend of 33.4p paid in 2023 yields 7.1%.

That said, the UK’s largest general insurer and a leading life and pensions provider increased this year’s interim dividend by 7%.

If this were applied to 2023’s total dividend return it would jump to 35.7p. This would give a yield this year of 7.5%, based on the current share price.

Looking further ahead, analysts forecast the payout will rise to 38.5p in 2025 and to 41.4p in 2026. On the present share price, this would give respective yields of 8.1% and 8.8%.

These are very high compared to the current average FTSE 100 return of 3.5% and the FTSE 250’s 3.3%.

Building an investment nest egg

Using only the current 7.1% yield, £11,000 (the average UK savings) would make £781 in dividends in the first year.

On the same average yield, the dividend payments would rise to £7,810 over 10 years, and to £23,430 after 30 years.

However, these dividend payments could be boosted enormously by using a common method in stock investment – ‘dividend compounding’.

The dividend-compounding boost

This involves using the dividends paid by a stock to buy more of it. It is a similar idea to leaving interest to accrue over time in a bank account.

Using this process on the same average 7.1% yield would produce an extra £11,327 in dividends after 10 years, not £7,810. And after 30 years on the same basis, there would be an additional £80,984, not £23,430.

Adding in the original £11,000 investment would give a total value for the Aviva nest egg of £91,984. This would be paying £6,531 every year in dividends, or £544 each month!

How does the share value look?

There is little point in making these returns if they are then wiped out by share price losses. This is why I only ever buy stocks that look undervalued compared to the shares of similar companies.

It not only reduces the chance of this happening but also increases the likelihood of stock price gains over time, in my experience.

The starting point here for me is the key price-to-earnings ratio (P/E) stock valuation measure. On this, Aviva shares currently trade at 10.1. This is bottom of its group of competitors, which has an average P/E of 28.7.

What’s a fair value for the stock?

So, it is very cheap on this basis. But how cheap exactly in cash terms?

To ascertain this I ran a discounted cash flow analysis, which shows the shares to be 48% undervalued at their present price.

So a fair value for the stock would be £9.10, although they might go lower or higher than that.

A risk to this is the intense competition in the sector that might reduce Aviva’s profit margins.

As it currently stands, though, analysts forecast that its earnings will rise 4.6% a year to the end of 2026.

For its yield – which I also think will rise strongly to end-2026 at minimum – and its heavy undervaluation I will be adding to my existing Aviva holding very soon.