Bank Of America Is My Best Subversive Dividend Idea

| About: Bank of (BAC)
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Bank of America currently makes $10-$11 billion in annual profit and can readily support a $3 billion dividend payout.

Bank of America presents a margin of safety in terms of stock price, as the $15 share price trails the $21 per share book value.

The value lies in the fact that too many folks are looking to the bank's admittedly troubled past and are ignoring its intriguing future ability to create wealth.

Did any of y'all see this release about Bank of America (NYSE:BAC) posted in the Wall Street Journal yesterday?

When it comes to a dividend increase, Bank of America and its shareholders hope the third time is a charm.

The Charlotte, N.C., lender is asking regulators to reapprove a five-cent-a-share quarterly dividend, according to people familiar with the matter, a test of its ability to please investors and appease the Federal Reserve at the same time.

For those of you who have been keeping up with the company, you know that Bank of America initially received permission to raise its quarterly dividend to a nickel, and then lost that permission when it reported a $4 billion calculating error to the Fed. By August 10th, we will know whether the Fed approves Bank of America's request for a $0.20 annual dividend (Bank of America originally planned to buy back $4 billion worth of stock and pay out a $0.20 annual dividend, but this current request keeps the dividend request intact while lowering the amount of the requested buyback. To my knowledge, the new buyback request amount has not yet been released publicly).

Bank of America is a stock with an ugly, ugly, ugly 2007-2011 history. The financial crisis rocked what was once one of the safest banks in the country, reinforcing the need for diversification for those contemplating bank investments (as well as those contemplating technology or high debt investments. And broadly speaking, you could intelligently make the case that portfolio diversification is a need for almost every lay investor).

Bank of America's ugly 2007-2011 history clouds the emotions of many people contemplating a Bank of America investment. Some people who own the stock now condemn anyone who notes Bank of America's rough seven year past by saying it's time to move on. Others refuse to assess the bank going forward because of the severity of the wounds caused by lowering the dividend from $0.64 quarterly to a penny per share, and doubling the share count without getting much in return (thus permanently impairing Bank of America's ability to recovery).

Although taking the middle ground is not always the right path, it's where I find myself on this issue: I like to acknowledge that Bank of America screwed up badly during the financial crisis, causing severe damage to innocent long-term shareholders that relied on the Bank of America dividend payment to fund their own mortgage payments, food budgets, and tuition expectancies for children. That being said, Bank of America is on the mend directionally speaking, and the disgust over its past has created an opportunity where those too busy looking backward are ignoring the fact that the company is making $10-$11 billion in profit this year, even taking into account its ongoing litigation settlements.

You've seen my profiles on this site before about how Johnson & Johnson and McDonald's went through periods of cheapness because there existed a disparity between the actual honest-to-god business performance and the public perception which affected the stock price. Bank of America is one of those companies right now.

Without much difficulty, Bank of America will be paying out $3 billion or so in total dividends on its $10-$11 billion in net profit. I can't tell you if it will be this quarter or next quarter, and sure, there is a realistic worst-case scenario where it might a bit more time to get there, but directionally, that is where the company is headed.

The company is cut up into 10.5 billion shares, so that when it starts paying out a normalized dividend of $3 billion per year, we're looking at a minimum annual payment of $0.285 per share each year. In other words, Bank of America easily has the present capacity to pay out $0.07-$0.08 per share each quarter, but is only requesting $0.05 because (1) they're just trying to get out of the Fed's doghouse and (2) they want to conduct stock buybacks with the remaining excess capital so they can get the share count down while the company is still trading below book value. A lower share count will eventually lead to a long-term ability to raise the dividend even more than would otherwise be the case.

Over the longer term, you could have a situation ten years from now where the payout ratio might be near 50%, profits will be higher across the company, and the share count will be materially lower. That's very fertile soil for dividend growth.

Bank of America is a very intriguing investment precisely because it offers a higher margin of safety than most people think. First, it has a margin of safety in terms of quality. Because it gets made fun of in the headlines every single day, people don't actually dig through the 10-Ks and annual reports to see that the company is profitable to the tune of $10 billion per year.

You get another margin of safety in terms of stock price. Right now, a lot of people are paying premiums to make a stock purchase. Bank of America's book value is in the $21 per share range (and usually, it's worth 110-140% of book value depending on the examination period), so the Bank of America stock price gives you a nice discount there because you can establish a position today at $15-$16 per share.

If you have the tolerance to deal with owning something that regularly gets mocked, have a time horizon exceeding five years, and seek escalating income, Bank of America is worth considering because the payout ratio stands to escalate in the coming years, and if you wait for the company to get a couple years of dividend increases under its belt, you run the risk that the stock price will appreciate too substantially by then because the typical response to increased certainty is a stock price increase that reflects it. Investing in Bank of America requires some boldness, but not quite as much as you think once you dig into the numbers and realize how profitable the bank already is right now.

Disclosure: The author is long BAC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.