By: Dividend Sensei
Strong Dividend Growth Means Market Beating Return Potential
Today Bank of America’s forward yield, after its 25% dividend hike, is 2.1%. While that’s only slightly higher than the S&P 500’s 1.8%, analysts expect the bank to be able to grow its dividend by as much as 12.5% over the coming decade. Now of course that kind of long-term forecast must always be taken with a grain of salt, especially since during a recession (which is likely coming within a decade) bank profits will fall and the dividend might have to remain frozen for a year or two.
However, given that Bank of America’s forward payout ratio is just 24%, and the Federal Reserve just lifted its soft cap limiting payout ratios to about 35%, it’s likely that Bank of America’s dividend faces several more years of very strong growth ahead of it. That’s because safe banking dividend payout ratios are in the range of 45% to 55%, as the legendarily safe Canadian banks have shown us (none of which has cut a dividend in over 100 years). This implies that Bank of America is likely to be able to grow its dividend faster than earnings for many more years to bring its payout ratio to this max safe range of about 50%. And thanks to billions in ongoing cost cutting, largely driven by its switch to lower cost and higher margin mobile banking, Bank of America’s earnings are likely to see continued strong growth as it continues down its path to becoming one of America’s leanest and most profitable banks.
Long-Term Dividend Growth Potential: 12.5%
Long-Term Total Return Potential: 14.6%
S&P 500 10 Year Projected Total Return: 4% to 8%
Valuation: 23% Undervalued
Historically (since the 1950’s) total returns for dividend stocks track the formula yield + dividend growth. That’s because valuations tend to mean revert over time (stay the same) and dividends grow in line with earnings. Thus Bank of America has the potential to generate almost 15% total returns over the next decade (on a compounded basis). Or to put another way, buying the stock today means you can potentially quadruple your money in 10 years. That’s far superior to the approximately 79% total return the S&P 500 is likely to generate over that time (from current valuations).
Bottom Line: Bank Of America Is Now A Grade A, World Class Bank Worth Buying Today
Don’t get me wrong, I’m not saying that Bank of America, or any bank for that matter, is going to be able to deliver this kind of impressive earnings and dividend growth every year. Like all banks, its fortunes are tied to the economy. And so when the next recession hits, it’s likely to face some negative earnings growth that will likely force it to freeze its dividend for a year or two.
But I am highly confident that today’s Bank of America is nothing like the one that nearly brought down the economy. CEO Brian Moynihan has turned it into one of the most conservative banks on Wall Street, with incredibly tight lending standards, and a fortress like balance sheet that passes the Fed’s simulated economic calamities with flying colors year after year. And at today’s attractive valuation, I have no trouble recommending income investors who are willing to ride out the share price volatility of a future recession, consider opening a position in what I consider to be one of the best banks in the world.