Are Promises of Bank Stock Dividends Worth the Risk?

By: Nilus_Mattive

Dividends have been all over the news lately, including a number of stories talking about the possibility that banks will begin paying out solid dividends again.

Well, it might be a week for giving thanks, but I’m certainly not going to include financial firms in my list at the table this Thursday. Nor am I going to recommend that income investors suddenly start piling back into the group whole hog, either.

Before I explain why, let’s first talk about a little recent history …

Leading up to the financial crisis of 2008, financial stocks were a great place to find solid income. In fact, they were the largest contributor of dividends to the S&P 500 index by far. But that quickly changed:

• In 2008, financials kicked in 20.48 percent of the market’s payments, seven percentage points more than any other sector …
• By 2009, as dividend cuts came to the fore, financials were contributing only 9.04 percent of the index’s dividends, less than even technology …
• And that trend has continued into this year, with the group’s share of dividends dropping again to 8.85 percent through November 2 …
• Worse yet, the group used to yield 4.44 percent back in ’08 … but today financials are yielding a measly average of 1.13 percent, the lowest of any S&P 500 sector (based on paying issues)!

Obviously, the biggest reason financial stock dividends went the way of the dodo was because banks’ underlying businesses were getting absolutely killed. The cash simply wasn’t there to pay investors. Heck, many of the banks themselves were no longer there to pay investors.

In recognition of this dire trend, Washington regulators stepped in and actually limited the amount of dividends that banks could pay out to investors. That was back in February 2009, when the Federal Reserve told its regional supervisors that banks should cut dividends if business or economic conditions weakened. And financial dividends have stayed down ever since.

So Why All the Fuss Over Financial Firms Now?

Earlier this month, there were rumblings that the Fed was about to reverse course and allow banks to raise dividends again.

Sure enough, last week they issued new guidelines on how they will go about determining which banks can increase dividends and buy back shares going forward.

The basic idea is that financial companies will have to take new “stress tests,” demonstrating that they have the wherewithal to survive another economic downturn and meet other new guidelines.

JPMorgan Chase is one of the companies already interested in increasing its dividend, and apparently other firms from Wells Fargo to U.S. Bancorp are champing at the bit, too.

Good News? Yes. Good Buys? Maybe Not!

Look, as a dividend investor, I’m always happy to hear that more companies may soon be increasing their payments.

I think there are better places to chase dividends!

But while other folks have been bidding up bank shares on this news, I remain more skeptical for two reasons:

First, banks are still fighting an uphill battle. The mortgage crisis isn’t over yet. Consumer credit remains challenged. And rock-bottom interest rates might not be there to boost results forever. Should we really count on another round of government-sponsored stress tests to ferret these risks out?

Second, it will take a lot of hikes before these payments become meaningful again. JPMorgan Chase stock is yielding just 0.5 percent. Bank of America is handing investors a paltry 0.3 percent. Wells Fargo’s yield is 0.7 percent! As you can see, even if these companies quadruple their dividends, they’ll still be relatively sad places to find income.

And I can hardly call banks tremendous values at current levels anyway.

In contrast, many other sectors continue to boast above-average fundamentals … much higher dividends … and a lot more value to boot.

Like where?

Well, consumer staples, energy, and health care companies are currently the biggest dividend sectors in the S&P 500 … and I have been recommending many of these stocks in the portfolios that I run.

Meanwhile, I’m only positive on one financial firm at the moment — and it’s a niche insurance company, not a bank.

None of this means I won’t find a bank worth buying, of course. Nor does it mean that you should avoid the entire sector forever.

It simply means there are plenty of better places for dividend investors to feast right now. And for that, I’m thankful.

Best wishes,

Nilus

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