Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Analyzing the growth potential of a bank company’s dividend is tricky compared to other types of businesses. Large bank holding companies such as Wells Fargo are required to submit annual capital plans to the Federal Reserve in order to gain regulatory approval for dividend payments and share repurchases.
Wells Fargo must comply with strict leverage ratio requirements and liquidity coverage rules to avoid restrictions on capital distributions. Capital distributions can also be restricted upon the occurrence of various risk management triggers, such as stress tests.
Fortunately, Wells Fargo is extremely well capitalized. The company has grown its dividend every year since 2010 and last received permission from the Federal Reserve in March 2015 to increase its quarterly dividend by 7%.
As seen below, Wells Fargo’s dividend is now higher than it was prior to the housing crisis (4.0% annual growth rate since 2005) after sharply recovering over the past five years.
Source: Simply Safe Dividends
Should interest rates begin to edge up over the coming years, we believe Wells Fargo can generate a mid-single digit earnings growth rate. When coupled with the company’s 36% earnings payout ratio and healthy capital levels, we think its dividend can continue growing at a mid-single digit pace. However, capital distribution will remain subject to the Fed’s blessing.
Valuation
WFC’s stock trades at 11.8x forward earnings estimates and has a dividend yield of 3.0%, which is significantly higher than its five-year average dividend yield of 2.4%.
Investors have beaten down shares of bank stocks in recent months on speculation that interest rates and economic growth will remain lower for longer, limiting loan growth and net interest income.
While stricter capital requirements prevent banks from earning the high returns they enjoyed prior to the financial crisis, we believe they can still generate a return better than utility stocks (Wells Fargo’s return on equity last year was about 14%) while enjoying at least mid-single digit earnings growth as the recovery continues.
Under those assumptions, Wells Fargo’s stock appears to offer annual total return potential of 7-9%, and it currently trades at a meaningful price-to-earnings multiple discount to utility stocks and the broader market.
Conclusion
Wells Fargo & Co (NYSE:WFC) is a wonderful company with numerous competitive advantages, including its scale, brand reputation, growing low-cost deposit base, diversified mix of businesses, broad distribution network, efficient operations, and conservative management team.
While bank stocks will always be more challenging to evaluate given the number of subjective assessments management teams must make to account for loan quality on the books, most banks are much healthier and better capitalized today than ever before.
It will take time for Wells Fargo to regain its reputation as a blue chip dividend stock, but we agree with Warren Buffett’s recent buying activity that suggests he thinks the company is attractively valued and remains a great long-term investment.
The stock will also benefit if interest rates begin to rise, providing diversification to dividend portfolios that are otherwise overly dependent on low-interest rate beneficiaries such as utilities and real estate investment trusts.
Disclosure: None
