When it comes to capital distribution policies, many investors focus their attention almost exclusively on dividend payments. But this is actually a short sighted approach to the matter: total yield, which includes dividends plus stock buybacks, is a much more complete measure of the amount of money that the company is distributing to investors. In fact, under certain circumstances, buybacks can be more efficient and rewarding for investors than dividends.
After the recent annual review of capital plans by the Federal Reserve, there are some compellingly high total yields to be found among the big American Banks.
Approved by the Fed
The most surprising winner from the Fed´s review was clearly Bank of America Corp (NYSE:BAC), the company has been trying to put its financial house in order for a long time, and getting approval for a $5 billion buyback is a remarkably positive sign for investors. This represents nearly 3.8% of its shares outstanding, which in addition to a paltry 0.3% dividend yield puts the total yield at 4.1%.
Not bad at all for a bank which has been going through so many troubles and receiving tons of criticism since the financial crisis. Besides, getting approval from the Fed to repurchase shares should be seen as a welcome sign when it comes to evaluating the company´s financial strength and the effectiveness of the balance sheet cleaning that management has undertaken over the last years.
Wells Fargo & Co (NYSE:WFC) was another big winner, it got approval to increase both its dividend and its buyback program, and it now pays a 5.2% total yield built from 3.2% in dividends and 2% in buybacks. This is hardly a surprise; Wells Fargo is a couple steps above its industry peers when it comes to financial soundness and overall risk management policies.
Importantly, its superior financial position has allowed the bank to gain market share versus the competition in businesses like mortgage lending, where Wells has consolidated itself as a market leader while other banks were still trying to streamline their assets over the last years. A stronger financial position means not only a safe yield for investors in Wells Fargo, but also better opportunities for growth and balance sheet expansion.
Goldman Sachs Group, Inc. (NYSE:GS) and JPMorgan Chase & Co. (NYSE:JPM) will need to reformulate their capital plans and send them back to the Fed for further review. The Fed didn´t object their requests on buybacks and dividends though, so the most likely scenario is that investors will receive big total yields of 8.4% and 6.1% in Goldman Sachs and JP Morgan respectively. While Goldman Sachs Group, Inc. (NYSE:GS) is heavily focused on buybacks, JPMorgan Chase & Co. (NYSE:JPM) has almost evenly divided its capital distribution between dividends and repurchases.
These two are offering the highest yields in the group, although they carry more uncertainty because of the mild rebuke they received from the Fed. These institutions have a big exposure to investment banking, and this is probably a drawback in terms of asset transparency and risk assessment.
When it comes to Citigroup Inc. (NYSE:C), the bank got approval for an especially humble request. Citi will implement a small buyback program of $1.2 billion combined with an even smaller dividend of a penny per share. The total yield paid to shareholders will remain below 1% in 2013, so there is not really much to get excited about in this case. It looks like management has decided that it´s still necessary to continue building capital, so Citigroup investors will have to wait until next year at least for bigger capital distributions.
Dividends vs. Buy Backs
When a stock is undervalued, buybacks are a better idea than dividends, since a repurchase means the company is not only returning cash to investors, but also investing its money in an attractively valued asset: its own shares.
This is particularly the case for Bank of America Corp (NYSE:BAC) which is trading at the lowest price to book value (P/BV) ratio in the group below 0.6. Goldman Sachs Group, Inc. (NYSE:GS) is not as undervalued as Bank of America, but it’s planning to implement a juicy buyback program which comprises 7% of its shares outstanding over the next year.
If the sector continues recovering and these stocks keep rising over the next years, this decision to put buybacks before dividends will turn out to be a smart move by management and a positive decision in terms of capital allocation. Under these scenario investors in Bank of America Corp (NYSE:BAC) and Goldman Sachs will be handsomely rewarded by the buybacks implemented at low valuations.
Wells Fargo is more on the dividend side, but that is understandable since the stock is not as cheap as the rest of the group with a P/BV ratio of 1.26. When it comes to JPMorgan Chase & Co. (NYSE:JPM), the bank is trading at a similar valuation to that Goldman Sachs Group, Inc. (NYSE:GS) in the area of 0.92, but Jamie Dimon has decided to split its capital distribution policy almost evenly between dividends and buybacks. Wells and JP Morgan are prioritizing the safety of dividends over buybacks, choosing a bird in hand over two in the bush.
Bottom Line
Many big American banks are offering big juicy yields, but you won´t discover that by looking only at dividends, a more comprehensive approach to total yield including both dividends and buybacks is required. Especially in cases like Bank of America Corp (NYSE:BAC) and Goldman Sachs, where the stocks are cheaply valued and buybacks are a big component of total yield; this may actually be best way to go when it comes to maximizing overall long term returns for investors.
The article These Big Banks Are Paying Huge Yields originally appeared on Fool.com and is written by Andrés Cardenal.
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