Bank of America (NYSE:) stock has another reason to move up. BAC increased its quarterly dividend 20%, from 15 cents per share to 18 cents. Its earnings per share gained 17.5% year-over-year in the June quarter.
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Bank of America’s massive share buyback program was a major reason for the high EPS and dividend per share growth. The repurchases leveraged the underlying financial growth.
For example, net income rose just 7.4%. But BAC spent $23 billion in share repurchases in the past year to June. This reduced its shares outstanding by 6.7% over the year.
So earnings per share, now much lower than a year ago, rose at over twice the growth rate of net income in actual dollars.
BAC’s dividends also rose at this faster per-share rate. In both periods, Bank of America paid out the same ratio of dividends to earnings.
BAC Benefits From Higher Interest Rates
BAC bought back so many shares because it is harder to produce earnings gains in low-interest environments. Banks like higher rate economic conditions. This juices the amount of interest they earn in their spread. This is called the net interest margin. Here is how that works.
Savings and checking accounts pay almost no interest and cost Bank of America almost nothing. Banks can’t really lower these costs when interest rates fall since they pay almost nothing to depositors anyway.
Banks earn a net interest margin on the interest from their investments funded by deposits. Most of those investments are loans, but they also include interest from government-backed securities.
So the bank’s investment return spread suffers if the loans and government securities pay less net interest margin or yield.
Bank of America’s net interest yield . The Federal Reserve cut interest rates in July. This lowered BAC’s net yield in Q2. The Fed cut rates again on Sept. 18, so BAC will have some margin challenges in Q3 and Q4.
Not to worry, though. Bank of America’s revenue sources are well-diversified. BAC makes almost as much in non-interest income as it does in net interest income.
For example, in Q2 BAC made $10.9 billion in fees and trading income, which is close to its $12.2 billion in net interest income. So its non-interest income helps smooth out BAC’s revenue and earnings in periods of lower interest rates.
How does this affect the BAC stock price?
BAC Stock Dividend Growth and Yield Comparisons
Bank of America stock price has a dividend yield of 2.4%. This is below other big money-center banks.
JPMorgan Chase (NYSE:) stock yields 3%. Citigroup (NYSE:) stock yields just under 3%. Morgan Stanley (NYSE:) is at 3.2% and Wells Fargo (NYSE:) is at 4.2%.
BAC stock has some catching up to do in terms of dividend yield. On the other hand, BAC pays out less of its earnings in dividends than these other money-center banks.
BAC’s payout ratio is 28.6%, whereas the payout ratio at JPM is 39.3%, C’s is 31%, MS 29.2%, and WFC 44.8%. Bank of America keeps its payout ratio low so that it can spend more on buybacks. As a result, its dividend per share grows faster. BAC’s dividend has grown faster than most of these other banks.
For example, over the past five years, BAC’s . JPM grew its dividend 18.5%. C stock’s dividend growth rate is 107.5%, the MS dividend grew by 40.6%, and WFC’s dividend grew just 7.36%.
The Dividend Yield or Growth Trade-Off
So you see the trade-off. Higher dividend-yielding bank stocks have lower dividend growth rates.
Which would you rather have? A slightly lower dividend yield and a much fast dividend growth rate, or the opposite? it is better to hold a faster-growing dividend stock than a higher yield stock. The main reason is that the fast-growing dividend tends to signify confidence in the underlying growth of the company.
Bank of America stock benefits two ways from its large share buybacks. It helps earnings per share grow faster despite slower growth in underlying net income from lower interest rates. It also allows the dividend per share growth rate to climb higher, given a steady payout ratio.
Stick with BAC stock despite its lower dividend yield. BAC’s buybacks and dividend growth rate are the best bet in this low interest rate environment.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the which you can review here. The Guide focuses on high total yield value stocks and was launched on August 30. Subscribers during September receive a 20% discount, plus a two-week free trial.
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