Image source: iStock/Thinkstock.
Could Bank of America (BAC 1.53%) soon double its dividend?
My colleague Sean Williams thinks so, writing last week that a "string of dividend increases could be right around the corner for B of A, leading to a possible doubling of its dividend within the next five years."
Sean knows a lot about investing, but I nevertheless thought I'd run the math on his prediction. After doing so, I believe that the only thing Sean might have gotten wrong is that he was too conservative in his belief that it would take five years for Bank of America's dividend to double.
The math is simple. In the first quarter of this year, Bank of America paid out $517 million in common stock dividends. That equates to $2.1 billion on an annualized basis, or $0.20 for each share of outstanding stock.
For Bank of America to double its dividend, then, it would have to be able to pay out $4.2 billion a year.
Is this possible?
Absolutely.
Bank of America's headquarters in Charlotte, North Carolina. Image source: iStock/Thinkstock.
Most banks strive to allocate their net income equally among dividends, stock buybacks, and retained earnings. As such, a typical bank tries to pay out somewhere in the neighborhood of 33% of its net income each year to shareholders.
The Federal Reserve, which has veto power over bank dividend plans, also prefers banks to stay around this threshold. As a result, so long as Bank of America can earn at least $12.6 billion on a sustainable basis, or three times $4.2 billion, then there's little reason to think that it won't be allowed to soon double its dividend.
To be clear, Bank of America has struggled to produce consistent profits since the financial crisis. Last year was the first time since 2007 that it earned more than $12 billion in annual income.
But this is changing. The primary impediments to Bank of America's profitability over the last eight years have been elevated credit and legal expenses. Since 2010, these have cost it a combined $202 billion.
The good news is that these costs are now largely in the rearview mirror. A court case last year slayed much of its outstanding legal liabilities, and the quality of its loan portfolio is at a multi-year high, as it is at most banks throughout the industry.
Its 2015 profit reflected this. It earned $15.9 billion last year, reporting four consecutive calendar quarters of respectable profitability for the first time in nearly a decade.
It's important to note that Bank of America's first-quarter results this year show that it still has work to do before its profits are sufficiently consistent for the Federal Reserve to approve a doubling of the bank's dividend. It earned $2.7 billion in the three months ended March 31, 2016. That comes out to $10.8 billion on an annualized basis, which is less than the $12.6 billion it needs to double its dividend but still pay out no more than a third of its earnings.
But the first quarter was particularly challenging for all banks, and with interest rates seemingly set to increase at some point over the next year or two, the stars are beginning to align in Bank of America's favor, at least insofar as its dividend is concerned.
In short, I think Sean is right. Although it's been a rough ride for Bank of America shareholders over the last decade, it doesn't seem unreasonable to anticipate, as Sean does, that it "will evolve into a dividend gem in the coming years."
