Recently I laid out the case for what a special dividend might look like from JPMorgan (NYSE:JPM). As a result of the material increase in the company's share price this year, CEO Jamie Dimon mentioned that at some point he might prefer a special payout instead of buying out past partners at a higher and higher valuation. This idea was shared in his comments at the Goldman Sachs US Financial Services Conference.
Also included were his thoughts on the dividend payout ratio. An analyst asked if Dimon thought the ratio could get up to 40% or 50% of profits, and his answer was, "I do." Dimon went on to detail that holding a payout ratio artificially low effectively forces share repurchases, which may not always be an optimal form of capital management (like when the share price increases nearly 50% in less than a year); hence the reference to the potential for special dividends.
The eventual move to allowing big banks to pay out say 50% of earnings makes a lot of sense. The lower restriction has been in place to shore up balance sheets and used as a means so to not create an unreasonable baseline for dividend payments moving forward should we (when we) hit another stumbling block. However, eventually companies have "shored up" all they'd like to shore.
JPMorgan has underlying earnings power of about $6 per share right now and pays out a $0.48 quarterly dividend - good for a payout ratio closer to 30% as opposed to 50%. On a company-wide basis JPMorgan is set to pay out ~$7 billion in dividends compared to a $10.6 billion share repurchase authorization (still equating to a total payout ratio of ~80%).
So it's not a matter of having the funds or even having the funds available to be allocated. Instead, it's simply a matter of allowing some funds that were previously earmarked to buy out past partners to instead be distributed among all shareholders. I recognize the cautious regulatory stance coming out of the recession, but this "higher" payout (read: change in allocation) doesn't strike me as a particularly far leap.
The current consensus intermediate-term growth expectation for JPMorgan is around 6%. At that rate the company would be earning around $8 per share after five years. Should JPMorgan be paying out 50% of its profits in the form of a dividend, you'd be looking at a $1.00 quarterly payout. This represents a growth rate north of 15% per year.
If instead you suspect that it could take 10 years before the bank is allowed to pay out 50% of profits as dividends, this would imply a future payout of about $5.40, good for a growth rate of nearly 11% per year.
Even at a 40% payout ratio and 6% underlying earnings growth, you're looking at 11% growth over a five-year period or 8.4% annual growth during the course of a ten-year period. The bottom line is the dividend is apt to at least grow in-line with earnings, but probably a bit (or a good deal) faster.
And naturally this illustration is not limited to JPMorgan. Wells Fargo (NYSE:WFC) currently pays a $0.38 quarterly dividend and has underlying earnings power near $4 per share. The expectation is for 7% intermediate-term growth.
Using those numbers, a 50% payout ratio after five or 10 years would equate to a dividend growth rate of 13% or 10% per year respectively. A 40% future payout ratio with the same assumptions would translate to 8.1% or 7.6% per annum growth respectively.
Or a firm like Bank of America (NYSE:BAC) could show exceptional growth from its very low starting point. The company currently pays a $0.075 quarterly dividend against underlying earnings power closer to $1.50 per share. The expectation is for rather solid earnings growth; for our example we'll still use 7% again.
At that rate, a 50% future payout ratio would translate to 30% or 17% annual payout growth over a period of five or 10 years. Even with a 30% payout ratio, you'd be looking at the potential for 16% or 11% annual payout growth over the five and 10-year periods.
After five or 10 years you'd anticipate a future 50% payout ratio to equate to 13% or 9% annual payout growth. With a 40% payout ratio you'd be looking at 8.2% or 6.6% annual dividend growth over the half-decade and full-decade periods.
I could do more examples, but I believe you get the idea.
If I asked the average investor to name a group of securities with strong dividend growth prospects, I'd contend that big bank companies would not come up on too many lists. This would be the case for any number of reasons. For one thing, the memory of the dramatic dividend cuts is still somewhat fresh. Second, the payments of many of these companies have already come quite far - even reaching and exceeding the previous marks in some cases. And third, you know that regulation has been artificially holding the payout ratios down.
Yet this doesn't mean it will occur forever. It's not a far leap to suggest that dividend payout ratios for large banks will be higher in five or 10 years as compared to today. As such, there's still a long way to go in the sector's dividend growth story.
Disclosure: I am/we are long WFC, JPM.
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.