I have recently written about how the next five years may be a mini-golden age of sorts for financial companies that are restoring their artificially depressed payout ratios to levels that are within hailing distance of pre-financial crisis norms. Most of these financial companies are doing it by offering investors a combination of dividend raises and stock repurchases. Many of these companies have attractive 5+ year potential because they stand to reward shareholders from both the underlying growth of the earnings mixed with higher payout ratios.
For instance, Wells Fargo (WFC) has a long-term target payout ratio of 60% of earnings. Considering that Value Line is predicting that Wells Fargo will achieve at least 10% earnings growth over the coming five years, and considering that its payout ratio is around 40%, investors stand to benefit from a nice tailwind as the accelerating payout ratios enable investors to temporarily receive dividends and stock buybacks in an amount greater than the underlying earnings growth for the next 4-5 years. JPMorgan (JPM) has joined the party as well, raising its dividend by 20% this year and announcing plans to buy back $15 billion worth of its stock over the coming two-three years. If executed in a non-dilutive manner at prevailing prices (both "big ifs"), the company would reduce the share count by 8%. Bank of America (BAC) is in the middle of redeeming $5.5 billion worth of preferred stock, and will also buy back $5 billion worth of common stock. Presumably, the dividend increases at Bank of America will follow in the next year or two.
And now, we have word that American Express (AXP) is joining the chorus of companies rewarding share owners by announcing plans to buy back 150 million worth of the company's shares. In terms of expectations, I would assume that American Express management has the intention to become a buyback company much more than a dividend company over the five-10 years based on its past actions and current announcements.
The company paid out a dividend of $0.18 per share each quarter in 2009, and the company kept the payout steady at that $0.18 all the way through the first quarter of 2012 before raising it to $0.20 per share. Two weeks ago, American Express hiked the dividend to $0.23 per share. While these amounts have been meaningful, Value Line is predicting a sharp slowdown to 4% annual dividend growth over the medium term (presumably due to American Express's aggressive commitment to its buyback program).
American Express management has indicated that the new buyback plan will buy up to 150 million shares (the company has 1.1 billion shares outstanding). Furthermore, the company has specifically mentioned an intention to buy back $3.2 billion shares during the remainder of 2013. At present prices, that would amount to a 4.3% share count reduction this year if executed in a non-dilutive manner. If the company were to fully retire 150 million shares outstanding that would amount to a share count reduction of 13.63%.
To get a more realistic estimate, I would keep in mind that American Express has an efficiency ratio of actually retiring about 80% or so of the shares that it earmarks for buybacks (I manually removed the financial crisis era buybacks from my calculation because I believe that to be a one-time, non-recurring event. If you disagree with that presumption, feel free to disregard my analysis on buyback efficiency). If we assume a buyback efficiency ratio of 80%, that means that American Express will actually retire about 10.90% of its outstanding shares over the course of this program.
Even though the buyback amount is somewhat substantial, it is not enough to encourage me to buy at current valuation levels. The highest analyst estimate (in response to this announcement) predicts that this will increase earnings per share to $6.00 by the end of 2016. If we assume that American Express achieves this optimistic growth rate (due to a combination of the aggressive buyback and organic growth), the company will trade at $90 per share (assuming that the company would be trading at its historical P/E ratio of 15). Optimistically, that means we'd be looking at 38% capital upside over the next four years. Considering that is the high-end estimate, I would want to insist on a lower price to increase my margin of safety if those favorable growth estimates prove to be too rosy.