The trailing yield of the KBW Large Bank index (NYSEARCA:KBE) is about 6.6%, but the indicated forward yield is about 5.15% as shown in this chart.
We find that to be an attractive yield for a long term holding, which may yet have further to decline, but that will eventually recover and continue to pay an attractive and growing dividend income stream.
We like equity income. We like the tangible confirmation of strength by dividends versus reports from management that all is well, but more importantly — we like getting paid cash from the businesses we own.
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There are some stinkers in the index, but on a portfolio weight blended basis, key attributes are not so bad.
There are some outrageous executive compensation packages, but that’s life these days. We’ll let CALPERS and the like tackle that problem.
The 93 basis point earnings spread on assets is not great, but is OK. The payout ratio at 69% may be high, but it’s not dangerous.
The five-year average yield of 3.25% versus the forward yield of 5.15% indicates a future capital appreciation to lower the yield to more normal levels.
Of course some things could upset that capital appreciation assumption, such as long-term earnings being permanently impaired due to lack of an irresponsible lending market, a permanent upward shift in minimum yield expectations by investors, and adverse tax changes versus dividends.
More asset write-down shoes could drop due to defaults or a renewed market liquidity drop. Domino effects in the market are still possible due to institutional failures, or the Federal Reserve reducing its extraordinary liquidity programs.
Multi-year construction loan write-downs for large complexes may be less mature than mortgage loans. Credit card and consumer loan losses may mount, as food and energy prices continue to squeeze everybody.
The banks may raise more capital that is dilutive to existing shareholders.
We are not that pessimistic however (prior article on KBE). We think the large banks will survive and recover. In the interim, we are happy to earn an attractive dividend yield that is tax preferred and nominally higher than Treasuries, while we wait for the markets to sort themselves out.
We are overweight large banks, and plan to accumulate more.