Should Banks Focus On Bigger Dividends?

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Includes: AEP, BAC, C, ED, SO, WFC
by: Stone Fox Capital

Summary

The utility stocks hit new highs this week after the Brexit vote.

The bank stocks traded down toward yearly lows on the expected fallout in the financial markets from Brexit.

The stretched valuation difference in the sectors appears to stem directly on the dividend payments as the banks return higher capital amounts.

The banks can improve the market sentiment by increasing the dividend payouts this week.

A very interesting trend has developed that favors stocks with the highest dividend all most regardless of the value proposition of the company. A prime example is utility stocks trading at excessive P/E multiples and hitting new highs on the Brexit mess.

Conversely, the large domestic banks with strong capital levels based on the CCAR results and low P/E multiples saw their stocks collapse. What would make investors pass up the cheap banks for the relatively expensive utilities?

Utilities

The utility stocks of American Electric Power (NYSE:AEP), Consolidated Edison (NYSE:ED) and Southern Company (NYSE:SO) have seen substantial gains this year to new highs. ConEd has led the group with over a 37% gain in the last year.

AEP Chart

The amazing part is that the gains in the utility sector isn't necessarily due to better prospects in the sector. The stocks are understandably appealing with interest rates so low. The forward P/E multiples are now trading universally near 19x EPS expectations while the dividend yields continue to decline.

AEP Dividend Yield (<a href=

The lower dividend yields of these utility stocks are starting to merge with those of the large banks.

Large Banks

The large bank stocks of Bank of America (NYSE:BAC), Citigroup (NYSE:C), JPMorgan Chase (JPM) and Wells Fargo (NYSE:WFC) are all trading down near the yearly lows. Citigroup leads the pack with a nearly 32% decline over the last year.

BAC Chart

The stocks though aren't seeing a big deterioration in the earnings story. Clearly, the lack of interest rate hikes hurt the prospects for growth, but the lowed stock prices are pushing down the forward P/E multiples to the 10x EPS expectations level.

The very notable point is that the bank stocks of BoA an Citigroup trade with the lowest P/E multiples and the biggest losses in part related to lower dividend yields. The sector as well trails the utility stocks.

BAC Dividend Yield Chart

Sure the banks have a different set of risks than utility stocks, but the recent stress test results suggest any material risk is highly unlikely. Based on that fact, investors are clearly ignoring the total capital returns of the banks for a focus straight on the dividends.

If one viewed the total capital returns using the net payout yields method (net stock buyback yield plus the dividend yield), the banks far out class the utility stocks. A prime example is Citigroup that pays a meager dividend, but purchased roughly $6.5 billion in stock during the last four quarters. The utility stocks aren't buying stock at these levels.

AEP Net Common Payout Yield Chart

Takeaway

These stock movements appear to suggest the market is highly focused solely on dividend yields. The bank stocks would do shareholders a favor by increasing the requested dividend payment as part of the capital return requests this week.

Clearly, banks like BoA and Citigroup should logically repurchase shares with the stocks trading below tangible book value. The market though favors dividends so hopefully investors will be rewarded with a higher combination of both capital return options when the amounts are released later this week.

Disclosure: I am/we are long C.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.