Many income-focused investors are so blinded by the big dividends and big price returns of traditional income-equities such as REITS and utilities stocks, that they are completely overlooking the big dividends, low risk, and price appreciation potential of the big bank stocks. For some perspective, the following charts shows the recent and historical total returns of various big banks versus a variety of industry benchmarks such as utilities, REITS, financials and the S&P 500.
The table helps highlight the extent to which investors have preferred traditional big-dividend low-volatility investments like utilities and REITS, and the extent to which financials have sold off. In our view, now is a great time to consider some of the big dividend paying financial stocks because their risks have been dramatically reduced in recent years, and some of them are currently trading at very attractive valuations. Specifically, the recent Federal Reserve stress tests have added credence to the increased safety, and the Brexit-induced sell off has helped increase the attractiveness of current valuations. For your consideration, below we have highlighted some of the big dividend banks we do NOT like, some of the big dividend banks we do like, and provided information on the big dividend banks we own. For reference, here is an expanded version of the previous table:
Total returns data as of 6/30/2016.
Big Bank Dividends We Do NOT Like...
Bank of America (BAC):
We acknowledge that some more aggressive risk-taking investors may find this stock attractive, but Bank of America is an example of a big bank stock that we do NOT like. For starters, its price to book is low because the bank still carries many distressed assets on its books left over from the financial crisis. Also, it earns a return on capital that is lower than its cost of capital suggesting it destroys value with each new investment it makes. And even though Bank of America’s payout ratio is expected to rise following the latest round of Fed stress tests, it’s still lower than peers like Wells Fargo and JP Morgan, and we are not comfortable that it can be increased to similar levels anytime soon. You can read out full Bank of America Report here:
Citigroup (C):
Citigroup is another example of a big bank stock that we do NOT like. Some more speculative, risk-taking investors may believe in the long-term possibilities, but for us it’s just too risky and it does not fit our mandate for low risk and big dividend payments. For starters, Citigroups dividend yield (0.5%) is ugly. And even though regulators approved the bank this week to increase its dividend payout to what amounts to essentially a 1.5% yield, it’s still lower than peers and it’s still not attractive to us. Citigroup’s price to book ratio sits at only around 0.6x which is a tribute to the massive amounts of low-quality “garbage assets” it still carries on its books following the financial crisis. Whereas banks like JP Morgan largely escaped huge missteps during the crisis, Citigroup was left holding the bag, and they still hold it. Citigroup’s return on invested capital remains lower than its cost of capital which basically means it destroys value with each new investment it makes. Citigroup also has more exposure to emerging markets, which could help it rise if those markets rebound faster than the U.S. but this is a risky bet in our view. Citigroup’s legacy “garbage assets” will be a drag on its returns for many years to come.
Banco Santander (SAN):
If you are a speculating, market-timing, high-risk, bottom-caller, Banco Santander may be attractive to you, but it is too risky for us. The bank has suffered from failing US bank stress tests and the fallout from Brexit and the struggling Eurozone economy in general. Plus its home country of Spain remains economically challenged in particular. Further, its price to book ratio is distressingly low and its cost of capital is exorbitantly high and unattractive. This is not a big bank we care to own.
Deutsche Bank (DB):
Deutsche Bank is another unattractive big bank, but again we acknowledge it may be attractive to investors with a higher risk tolerance as well as those trying to time the bottom. The price has been severely reduced recently as it didn’t pass the Fed’s final round of stress tests and it has also been decimated by the recent Brexit news. In our view, its price to book is disturbingly low, and its return on capital is less than its cost of capital suggesting it destroys value with each new investment it makes. It doesn’t pay a dividend in the US anymore, and it may not be able to for many years. Additionally, Deutsche Bank may still face an enormous fine from investigations into its manipulation of foreign exchange markets. We are not interested in owning this bank.
Big Bank Dividends We Do Like...
Wells Fargo (WFC):
As the earlier table shows, Wells Fargo is a big dividend payer (3.2% dividend yield) that ranks favorably among big banks on several measures. For example, it has a low payout ratio (dividends plus share buy backs divided by net income) suggesting it has the ability to keep increasing its already high dividend payout. It also has a price to book that is above one because it has less distressed assets on its books than other banks, but it still has room for multiple expansion. It also generates a return on capital that is higher than its cost of capital (this is important).
Qualitatively speaking, Well Fargo does not have the risky capital markets operations that many of its peers do (e.g. Citigroup, Bank of America), but it still enjoys many economies of scale like other large banks. Wells Fargo also has the ability to improve profitability as interest rates rise. In particular, rates are near historical lows (especially in light of Brexit) which provides an attractive entry point for investors that believe rates will eventually rise again. Additionally, the price has significantly underperformed the market this year, which can be attractive for many value investors. You can read our recent full report on Wells Fargo here:
JP Morgan (JPM):
JP Morgan is another big bank with a big dividend (3.1% yield) that ranks favorably on a variety of important metrics. Like Wells (but unlike many of its other peers) JP Morgan generates returns on capital that exceed its cost of capital, which means it has the ability to grow profitably. It also has a price to book ratio near 1 suggesting it has less “garbage assets” left over from the financial crisis than many of its peers with much lower ratios. Plus, the near one ratio suggests JP Morgan has room for price multiple expansion.
Qualitatively speaking, JP Morgan has a massive branch and ATM network thereby benefitting from economies of scale. The bank may also benefit as interest rates rise as the net interest marging will expand. Additionally, JP Morgan’s stock price has been dragged lower along with other banks and perhaps it should not have been thus providing an attractive entry point for value investors.
Our Top 3 Big Bank Ideas:
...Impressive Dividends, Price Appreciation Potential.
In addition to the big bank dividends we’ve described above, this week’s members-only Blue Harbinger Weekly reviews our top 3 big bank ideas, including the two we already own, as well as this week’s new investment idea which happens to be another big bank with an attractively growing dividend, shrinking risks, and impressive price appreciation potential. If you are not already a member, consider a subscription.