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3 Types of Financial Dividends, Part 2: Micro-Dividends

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Just because a company pays a dividend, that doesn't mean it's a large dividend. In fact, some companies pay tiny dividends that are almost insulting to income investors. In this part of our three-part series on financial dividends (see also Part 1 and Part 3), I'll look at three companies paying what I call "micro-dividends," why they're doing this, and what could be in store for the future.

Big banks
Bank of America
(NYSE: BAC  ) and Citigroup (NYSE: C  ) both had a rough time during the financial crisis, accepting billions in government aid. Today both banks are bouncing back, although share prices are still well below their pre-recession levels because of a combination of market skepticism and massive share dilution.

Neither stock looks particularly impressive for income investors, either, as both banks pay a mere penny per share per quarter. With Bank of America shares trading at $16.77 and Citigroup shares trading at $54.72, B of A has a higher yield, but it's still a mere 0.24%, while Citigroup's is just 0.07%.

These tiny dividends are largely in place to allow the stock to be purchased by funds that are allowed to invest only in dividend-paying stocks. But with many income investors turned off by these small payouts, B of A and Citigroup are still missing a large portion of investors.

The financial crisis had a sharp impact on a lot of companies, but few felt the pain like American International Group (NYSE: AIG  ) , whose share price is down more than 95% since the collapse began. With the beginning of the collapse, AIG suspended the dividend on its common stock as the company rushed to secure the funds to avoid outright bankruptcy. Even after securing the funds, the large amount of money owed to the government would have made paying a dividend to common shareholders political suicide.

AIG's dividend has returned, but only after the government divested the last of its stake in the insurance giant. At $0.10 per share per quarter, AIG's dividend comes in at 0.77%. While that's larger than the dividends at B of A and Citigroup, AIG's dividend still lags the insurance industry, where Prudential Financial pays 2.34% and MetLife pays 2.03%.

Share buybacks
Share buybacks carry a number of advantages and disadvantages compared to dividends. Many times, buybacks are done when a company is at its highest valuation, making the buyback less beneficial overall and sometimes even value-destructive. However, this is not the case with buybacks at B of A, Citigroup, and AIG. With all these stocks trading well below book value, buybacks increase book value with each share purchased.

Share buybacks are also easier to turn on and off in case the company decides it needs to conserve funds. While cutting a dividend is often a red flag to investors, share buybacks can have termination dates connected to them so that when the buyback ends, the market accepts it as an expected event.

As a result of cheap shares and wanting the flexibility to retain capital without startling the market, BofA, Citigroup, and AIG have been buying back billions in stock. Although it's not the same as a dividend, these share buybacks do help enhance value for shareholders.

Dividend increases
All these companies are either embarrassed or should be by their dividends compared with their industry peers. As the economy recovers further in 2014 and each company generates more capital, I expect modest dividend increases at each. With a general bullish view on financials for 2014, I see all three of these companies moving their dividend yields closer to the 2% level to better compare with their peers.

Bank of America, Citigroup, and AIG all pay tiny dividends compared with their peers and past history. However, I view 2014 as a year for dividend increases and a return to respectability among income investors attracting additional buyers to these shares.

In the final part of this series, I'll examine three banks that pay no dividend, why this is the case, and what could happen going forward.

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Alexander MacLennan

Alexander MacLennan is a Fool contributor covering Industrials, Airlines, and Financial companies. He is always ready for a good growth or turnaround story and tries to find them before the market does.

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