Please ensure Javascript is enabled for purposes of website accessibility

What Investors Need to Know About Bank of America's Dividend

By John Maxfield - Sep 10, 2015 at 6:38PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Bank of America's history, plus the dynamics of the bank industry, strongly suggest that the nation's second-biggest bank by assets will raise its dividend consistently over the coming years and decades.

One of the reasons why investors traditionally loved Bank of America (BAC 0.08%) was because of its dividend. Although this changed during the financial crisis, when many of the nation's biggest banks slashed their quarterly payouts in order to accumulate capital, one of CEO Brian Moynihan's long-stated objectives has been to restore its once-generous distribution. It's for this reason that the otherwise ominous chart of Bank of America's quarterly distributions since the turn of the century is much more optimistic than one might at first assume.

There are two things to take away from this chart. The first, and most obvious, is the sharp drop that occurred in the fourth quarter of 2008 and the first quarter of 2009. As former-CEO Ken Lewis explained in his 2008 letter to shareholders:

In times of severe financial stress, what financial institutions need more than anything is capital. Bank of America has, for years, been among the most well-capitalized banks in the world. But the fourth quarter of 2008 tested even our ability to maintain a deep well of financial resources.

In early October, to shore up capital levels as credit losses accelerated, we raised nearly $10 billion through the sale of common stock and cut our dividend on common stock in half.

The move was difficult, but necessary; it's also not the most important takeaway from this chart. What's more important for current investors is Bank of America's previous history of consistently raising its payout. It did so every year between the turn of the century and the onset of the crisis eight years later. In that stretch of time, it went from $0.25 per share each quarter all the way up to $0.64 per share.

And this tells only half the story. If you extend the chart back three decades, you'd see that Bank of America's tendency to raise its dividend on an annual basis was a long-established trend. It had done so every year since 1977, back when Bank of America was known as North Carolina National Bank.

This is all history, of course, but I believe it's just as relevant today. Current CEO Brian Moynihan made it clear in 2011 that one of his main priorities was to reinstate a generous dividend payout, as well as to offset the dilution to its shareholders that occurred in the wake of the crisis. As Fortune's Shawn Tully noted at the time:

In explaining his current strategy, Moynihan divides the future into two main periods. Over the next two years, he says, Bank of America will retain virtually all its earnings to build the funds necessary to comply with the new Basel III international standards of capital requirements for financial institutions, which are anticipated to be stringent. [...]

When BofA has built up a sufficient capital cushion, probably two to three years from now, Moynihan plans to return all earnings to investors in dividends or share buybacks -- we're talking about $25 billion a year, all stuffing shareholders' pockets. "We need to get back most of the shares we issued in the crisis, that caused all the dilution," says Moynihan. It's a classic value strategy of growing modestly without plowing profits back into the business.

The bank has struggled to deliver on this promise, stumbling through three out of the five stress tests administered by the Federal Reserve, the results of which dictate whether or not the nation's biggest banks can return more capital to shareholders or not. But it finally got the go-ahead in 2014, increasing its dividend from $0.01 to $0.05 per share.

This is just a taste of what's to come. Banks have little choice but to pay out a significant portion of their earnings to shareholders. To do otherwise would mean that a bank is retaining an inordinate share of its earnings. And because retained earnings increase a bank's shareholders equity, they have the concomitant effect of decreasing its return on equity, which is calculated by dividing a bank's net income by its shareholders equity.

The net result is that publicly traded banks have every incentive to distribute at least a third of their earnings via dividends, leaving the remaining two-thirds to be split roughly evenly between share buybacks and retained earnings. Thus, as Bank of America continues to shore up its balance sheet and income statement, shareholders can assume that regular dividend increases will be one of the defining characteristics of the Charlotte, North Carolina-based bank's stock over the years and decades to come.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Bank of America Corporation Stock Quote
Bank of America Corporation
BAC
$36.70 (0.08%) $0.03

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
344%
 
S&P 500 Returns
120%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/27/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.