It's like trying to exhort a cantankerous donkey into doing something the donkey considers unnatural, optional and displeasing. Generally speaking, it's not easy to make me go in for a checkup at the doctor's office. This time, he asked about my general health, and whether I had any concerns. I told him - quite candidly - that since moving to Portugal three years ago, I've developed maybe a little bit too much of a taste for Portuguese wines (which are truly exceptional and very reasonably priced).
"I see" he intoned, nodding. "How much do you drink?"
"Well...." I replied, as I looked down at the floor and fidgeted guiltily, "it's probably between one-third to one-half of a bottle. Ummmm. Every night. With dinner. Sometimes."
My doctor peered over the top of his thick reading glasses with a look that could have indicated either shock, concern, or both.
"But... what about the rest of the bottle?"
And that is precisely how Doctor Pancake feels this morning whilst perusing the latest results of the banking sector stress tests published by the Federal Reserve. As it happens, I own very large positions in JPMorgan (JPM) and Citibank (C), which not only passed the stress tests with flying colors but also announced explosive dividend increases and share buybacks - blessed (or at least authorized) by the Federal Reserve. JPM - the dividend leaps from .56 to .80 cents a quarter, with $20.7 billion in new share buybacks. Citi - the dividend goes from .32 to .45 cents per quarter, with $17.6 billion in new share buybacks. Thanks to these new dividend increases, my portfolio income jumped ahead by over $1,300 a year while I was in bed last night. That comes to 145 bottles of the really REALLY good Portuguese white wines from the Alentejo that I enjoy - such as Pera Manca or Cartuxa. My doctor would be so, so proud.
What I like is an 8 Euro bottle that tastes like an 80 Euro bottle. It's all about exceptional value for exceptional quality. Most of us feel the exact same way about stocks, too. I mean, if I'm going to rot my liver, I'm going to insist on only drinking the good stuff, exclusively. Likewise, I just won't buy a stinker of a company simply because the stock is cheap. But give me an expertly managed blue chip company with 100 years of earnings growth history and a spotless credit rating? Oh, ho ho ho ho.
JPM now yields roughly 3% per share, and Citi comes in at a yield of 2.7%. JPM carries a PE ratio of 13, and a projected long-term earnings growth rate of about 5.75% if you go by the figures you see on NASDAQ. The PEG ratio is probably in the area of 2, which to me is a bargain when you're looking at a storied blue chip company with exceptional credit metrics. Citi has a lower PE ratio of 11.61 and estimated five year earnings growth rate of 10.68% according to NASDAQ, producing a PEG ratio of closer to 1. This is not complicated. Exceptional value for exceptional quality, and the dividends and dividend increases to prove the point.
But owning high dividend growth is not enough. I will not blow my $1,300 dividend increase on vino, but instead, I will be powering those dividends straight back into more shares of JPM and C. By doing so, I will magnify the impact of yesterday's dividend increases like an earthquake aftershock reverberating across time as that income compounds and then compounds some more. Reinvesting dividends into dividend growth stocks is basically like tossing gasoline on to a raging fire: FUN.
But Citibank and JPM are not why I am peering skeptically over the top of my reading glasses. The reason why is because I am now looking at Goldman Sachs (GS). I own about $34,000 worth of that stock, but looking over the stress test results, I seem to have conjured up for myself the same feelings as our Federal Reserve must have had whilst observing the capital adequacy of GS in the face of unlikely (but not unimaginable) financial stress. I have only one question for Goldman Sachs this morning: what about the rest of the bottle?
No dividend hike. No buybacks. GS seems to have passed its stress test with what translates to a C+.... hardly something to brag about. Not only does the stock yield a miserly 1.43%, but that skimpy yield comes with zero yield growth for the next year. And the estimated PEG ratio for GS is better than JPM, but no better than C, at least if you assume a 10% long-term earnings growth rate like you see on NASDAQ.
This is not complicated. Why accept a 1.43% yield with zero growth from a company with a BBB+ credit rating when you can have a 3% yield growing at 43% a year from a company with an A- credit rating, or a 2.7% yield growing at 40% a year? It is almost as if the stock market is pricing juicy, ripe oranges at the same price as slightly mealy apples that have some of those curiously unappetizing dry, brownish holes in the skin. I guess I don't need to debate the academic curiosities and subtleties of why and how the stock market prices risk and quality. I'm content to dial back my position in GS and power the proceeds straight into JPM and C, and in the process, to boost my portfolio's credit quality and organic dividend growth potential. Plus, reallocating some capital out of GS and putting it into JPM and C will immediately deliver $300 worth of increased cash flow. But the fun won't stop there. When that extra $300 of dividends comes in, I'll probably use it to buy a few more shares of JPM and C, too, and that will boost next year's income that much more.
What about the rest of the bottle? I'll tell you about the rest of the bottle. There will be no rest of the bottle. (1) Organic dividend growth; (2) reallocate capital from riskier, lower yielding stocks with lower dividend growth into higher yielding stocks with higher dividend growth; and (3) reinvest dividends. Year in, year out.
Disclosure: I am/we are long C, JPM, GS.
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: This is not investment advice and I am not an investment advisor. Nobody can rely on anything contained in this article for factual accuracy. Nothing in this article is a suggestion to buy, sell or do anything whatsoever with any security whatsoever.