How Big Banks Celebrated Passing Their Stress Tests

After passing the Federal Reserve's stress tests, Goldman Sachs (GS -0.71%), Bank of America (BAC -1.07%), Morgan Stanley (MS -1.38%), Wells Fargo (WFC -1.11%), and JPMorgan Chase (NYSE: JPM) all raised their dividends. In this episode of MarketFoolery, Motley Fool analyst Asit Sharma, with host Chris Hill, analyzes what's behind the moves as well as the latest quarterly results from office-furniture maker Herman Miller (MLKN 0.04%) and financial software-as-a-service (SaaS) company FactSet (FDS -0.97%).

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This video was recorded on June 29, 2021.

Chris Hill: It's Tuesday, June 29th. Welcome to MarketFoolery. I'm Chris Hill, with me today, Asit Sharma. Thanks for being here.

Asit Sharma: Chris, thanks for having me, I'm really excited to be here to talk to you this morning.

Hill: Well, we've got exciting topics like information data and our return-to-work stock, but we're going to start on Wall Street because the story of today is the big banks because after passing the latest stress tests from the Federal Reserve, most of the big banks decided to celebrate by raising their dividends. Goldman Sachs, Bank of America, JP Morgan Chase, Wells Fargo, and Morgan Stanley all raised their dividends, while those last two doubled their dividends. Citigroup (NYSE: C) is the only one of the big six to leave their dividend right where it is. I guess we shouldn't be surprised but when this has happened in the past, I don't recall it happening in this one fell swoop like this, even after the Great Recession. When you saw this news, what went through your mind?

Sharma: It reminded me of classes out of session and everyone getting out of the classroom with great relief and celebrating a bit, they pass this big stress test. They had some additional levels of capital requirements that were put on during the pandemic. Most of the big banks are signaling that they've been building the surpluses on their balance sheet since the Great Recession anyway and they're sort of ready for class to be out of this testing business, let's get on with life. I think for these big banks, part of that equation is signaling to investors that they were attractive investments too, don't forget about us, "Hey, investors, you've been beaten up by some high-growth stock names early this year? We're still here. We're raising our dividends." Chris, I looked after that announcement, Morgan Stanley, you mentioned doubled its dividends to $0.70 a share. That puts its dividend yield at 3%. That's a pretty attractive yield for a big bank and a solid bank at that.

Hill: I've never been so enamored of the big banks that I've thought about buying shares, particularly if you're looking at your portfolio and you're looking to fill out that dividend-paying section as some investors are. I think you have to look at this because a lot of them aren't just raising their dividend, but they have also announced over the past month or two various levels of share buyback programs. It seems like a pretty serious move as you said to signal to investors like, "No, we're serious about this, and we are going to reward shareholders, not in huge growth stock ways, but we're going to methodically reward shareholders for doing this." I am curious though, more broadly outside of the big banks. When you're researching a stock when you're looking at a company and thinking I might want to buy shares of this. Where does whether or not they pay a dividend fall on your list of things that you're looking at? Because I'm at a point in my life, even in my 50s, the dividend part still isn't that high on the list for me, it's on there, I'm curious about it and if they're paying a dividend, I want to know what their track record is. But at the moment, I can't think of a time where I've bought a stock and what swung it from the watch list to the buy button was the fact that they are paying a dividend.

Sharma: Chris, there is going to come a time maybe 20 years from now when that will be the first thing you go to, looking at that dividend yield and what it means to your portfolio. But like you, I am on the younger side of that equation, although it is in my consciousness, I will say I'm not quite as young as I used to be. Where it factors in is a factor or a piece of data that tells me something about where that company is on its own trajectory. Often, you're looking at a great cash flow generator, which is still in growth mode if you're not a dividend investor. Let's just say you don't even classify yourself and maybe, Chris, you fall into this bucket. You love growth stocks. You don't have a certain investment style that you go to the wall with. For you, yeah, the fact that the company is even paying a dividend makes you just examine what type of growth stock it is. Maybe it's on the more mature side of things and of course, there are some wonderful growth stocks that pay a dividend so we shouldn't run away from that piece of data. Microsoft is an awesome example of that. Yes, for me, it is just one part of the puzzle at this point in my investing career. Although I will say, I have three investing styles. I love growth stocks. I like a good value stock when no one else is looking and I won't make a fool out of myself and I'm starting to build an income stream for retirement. I do have a few stocks in my portfolio that pay dividends and just to bring it back to this conversation, why this is maybe interesting for those who are investors in big banks. 

We're looking at, for the first time in a while, a rising interest rate environment, which means, of course, these big banks rely less on trading activities and maybe a little bit more on that traditional cycle of net interest income. That is making the spread between the money that you deposit and what they can turn the money around for, in their own lending activities. This is something that might pull bank stocks in general a little bit back in favor. Combine that with these increased dividend yields and as you mentioned, the share repurchases, they are making a very evident reason for investors to take another look after several years of being a little bit out in the wilderness in the investment world.

Hill: On the surface, it was a nice end to the fiscal year for Herman Miller. First quarter profits and revenue came in solidly higher than expected. This is not one of those beaten by a penny type of quarters, but shares of Herman Miller are down 7% today due to guidance. The drop that we're seeing in the stock seems reasonable to me because this stock is still up 70% over the past 12 months. It's basically where it was in January of 2020 and it seems like the market is saying what it often says, which is, well, that's nice but what are you going to do in the next six to 12 months?

Sharma: Yes, and Herman Miller's problem is that it is still very much centered in the project business. What I mean by that is this company, which is known for the iconic Herman Miller chair and high-end furniture still makes the majority of its profits from office renovations and office furniture. It depends on bigger companies undertaking projects for new office space to grab the bulk of its orders. It's Ford orders, which is something that investors look very closely at in this industry. Orders actually look great in the quarter that just ended, they were up about 29%, but the backlog is down about five%. The things at Herman Miller is going to, I think convince investors off over the longer haul, is that they are able to carry their fashion fort sense and their ergonomic sense in office furniture into these new avenues that they were investing in before the pandemic so a greater emphasis on retail, which CEO Andi Owen has done a spectacular job of. She's increased the retail footprint of Herman Miller. 

The acquisitions from upscale brands like Hey Designs to this upcoming merger with another big name in the office furniture world, which is Knoll, K-N-O-L-L, these are things that I think Herman Miller will be able to capitalize on in the future. Just now investors, absolutely Chris are saying, OK, we can take a break for a while and see how maybe the next quarter pans out with this order-flow. I should say too we shouldn't leave out of this discussion how well the company is doing in its e-commerce. Those investments happened before COVID as well. Andi Owen, one of the first things that she did when she came in is to make sure that the e-commerce strategy would be robust. We're seeing really great results out of that. I think when you take this whole picture together, you've got a company, which will look fairly different a year from today after the merger with Knoll and the time that it will take for them to realize further results from investments made pre-COVID. But this morning, investors are looking at the uncertainty of the company's outlook, which was actually, I would say pretty middling, Chris, just looking at the numbers, sales are expected to be between $640 million and $670 million in this next quarter. That's just growth of less than 5%, which is a little less than investors are looking for.

Hill: FactSet Research Systems fell a bit today. Third quarter revenue for the financial software company came in higher than expected but profits were on the light side. Guidance was the same as Herman Miller's, it was fine it did not blow anyone away.

Sharma: Sure, well here you have another company run by a very capable CEO. Unlike Andi Owen at Herman Miller, who just came in a few years ago, Phil Snow has been CEO since about 2015. He started his career with this company as a consultant, working his way all the way up to the CEO position. As a result of that, I think you have a CEO whose focus has been on very steady growth. They are a competitor to Bloomberg and other data services. This is just what they delivered in this quarter. Chris, GAAP revenues were up about 7% to almost $400 million. Organic revenues made up most of that, but margins were a little on the slim side. Part of this is because the company had a greater incentive expense because its sales team delivered on some of the targets. You see this in the consumer goods world quite a lot, not as much as in the information technology world, but because of those targets being hit. They had to pay out a little bit more in incentives, hitting their bottom line by a few percentage points, nothing too major there. What I did like about today's release is that their annual subscription value keeps growing. Think of this as locked in value from customers who are buying their data sets on a subscription basis. 

They continue to work more and more like a Software-as-a-Service company in that regard. That organic ASV, if you will, is occurring at a nice clip of nearly 6%. But I think too the guidance going forward, while they increased the amount of annual subscription value that they foresee, they didn't really change the outlook for the year very much. I think investors wanted to see some momentum that FactSet wasn't able to provide. Again, overall, a really good picture for the long term but maybe this is going to be for not just Herman Miller and FactSet but a "show me." Show me a little bit more quarter. We're just getting into earnings season now so it could be a recurring story with a lot of companies, Chris.

Hill: Absolutely, and I think that on the plus side for FactSet, they do a really good job of retaining their clients. I think their client retention is something like 90%. This is not a consumer business, this is a big ticket item. When they make a sale, it's all the more important. Yes, they are switching costs, it's not to say they can't lose clients. They can and they will. I'm sure it's the same for Bloomberg, but the fact that they're keeping 90% of their clients, it speaks well of management. That they are looking to just continue to grow and deliver because clearly, that's been their track record to this point.

Sharma: Yeah, totally agree. When you take their dollar version of that retention number, it's 95%, so they're losing just a little bit but keeping most of their actual customers in terms of numbers, as you mentioned, 90% on a dollar basis. On average, customers are spending a little bit more when you take these two numbers together. These statistics show that it is holding onto all that market share it's been able to grab, not just from Bloomberg, but from smaller companies that are offering more specific data sets, they're seeing an increase in demand for analytics, which I think is going to only be good for them. As you look beyond the next two, three years, the ability to provide investment houses, private family offices, and institutions that aren't necessarily trying to invest in stocks but need the same data sets for other purposes. Also adding to their layer of indexing are data sets, which are good for people who follow, say, the ETF industry. All this together again, bodes well for a company whose hallmark is the solid, steady, I won't say boring growth because I think they would disagree with me. I think in this industry, mid-single-digit growth, ain't bad. All in all, a solid report and in fact, I should say for the last couple of quarters, I believe that's the term that management has used in its press release, that facts that delivered a solid quarter. I'm going to second that, that was a solid quarter.

Hill: The growth isn't boring, the business is boring. On the surface, this is not an exciting business, but you look at the growth chart of this company and yeah, that's the thing that you got to like if you're an investor.

Sharma: I think hordes of data scientists, data analysts, numbers guys, and I should say number people, yeah, numbers go out. I think they're looking up from their desks this morning after hearing this podcast and they want to argue with us, Chris, because to them, this stuff is really interesting.

Hill: Absolutely.

Sharma: I see that from their perspective.

Hill: You know what? That's great that there are people who get excited about this because they are the people who help create businesses like this.

Sharma: For sure.

Hill: You need people like this.

Sharma: You do.

Hill: Asit Sharma, great talking to you. Thanks for being here.

Sharma: Thanks as always, Chris. A lot of fun.

Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Austin Morgan. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.