Bank of America (BAC 1.70%) gave its shareholders a massive dividend increase in 2017, increasing its quarterly payout from $0.30 to $0.48 per share -- a 60% raise. This brought the bank's dividend yield to nearly 2%, which is a respectable, but not especially high level relative to other bank stocks.
However, shareholders shouldn't count on a similar dividend increase next year, or anytime in the near future for that matter. It's not because the bank won't be able to afford another dividend increase -- it simply believes it can put its profits to work for shareholders in a better way.
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Bank of America's preferred way of returning capital to shareholders
Bank of America pays a dividend, which has increased substantially over the past few years. In fact, the bank's most recent dividend increase was enough to entice billionaire investor Warren Buffett to exercise his warrants and become the bank's largest shareholder. However, Bank of America's preferred way of returning capital is clearly through share buybacks.
For the past several years, Bank of America has been buying its stock back aggressively. From 2013 through 2016, it authorized $18 billion in repurchases.
In 2017, the bank decided to take its buyback program to the next level in the wake of excellent stress test results. In June, management authorized a $12 billion buyback program, which is more than double the value of last year's authorization and represents roughly 5% of the bank's outstanding shares.
Shareholders shouldn't expect the aggressive buybacks to end anytime soon. "Our stock's a good buy and we'll continue to buy it until the cows come home," CEO Brian Moynihan recently said at a conference.
Moynihan went on to say that the bank wanted to be careful with its dividend increases, so as not to put itself in a position where it may have to reduce its payout. Regulators have implied that bank dividends shouldn't exceed 30% of earnings, so Moynihan wants Bank of America's to remain safely under that amount so the dividend can be maintained even if earnings were to drop unexpectedly. For reference, Bank of America's current quarterly dividend represents just 22% of its expected 2018 earnings.
Why does Bank of America's management think the stock is such a good value?
To reiterate, Bank of America is emphasizing buybacks for two main reasons -- so it won't have to cut its dividend if things go bad, and because management thinks the stock is a good value.
Since the latter is a primary reason most companies choose to buy back shares, let's take a look at why this may be true in Bank of America's case.
For starters, the bank still trades for an attractive valuation relative to peers. At just a 2% premium to its book value, Bank of America is much cheaper than rivals such as Wells Fargo (49% above book) or JPMorgan Chase (44% above book). This is despite excellent capital levels, dramatically improved asset quality, and improving efficiency and profitability metrics.
BAC Price to Book Value data by YCharts.
In addition, Bank of America stands to benefit from rising interest rates over the next few years. In fact, Bank of America estimates that a 100-basis-point increase in both short- and long-term interest rates could add another $3.2 billion in annual net interest income. Tax reform could also be a big positive catalyst for the bank, not only in terms of a dramatically lower corporate tax rate but with increased business if it actually produces strong economic growth.
In a nutshell, Bank of America is a cheap bank stock that stands to benefit from the economic and political climate over the next few years.
Bank of America is a low-dividend stock (for now), and that's OK
From a shareholder's perspective, especially if you're a dividend lover, Bank of America's 1.9% dividend yield is understandably nothing to get excited about. However, if you believe that the bank's shares are an attractive value as management (and Warren Buffett) does, it's in your best interest for Bank of America to continue to buy back shares aggressively for the foreseeable future. Doing so will increase the future earnings potential of your investment, and as a result, it will increase the long-term dividend generating potential as well.
