Bank of America Still Is a Solid Income Stock

Advertisement

According to the Wall Street Journal, Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B) made a paper profit of $11.4 billion August 29 exercising warrants to buy 700 million shares of Bank of America (NYSE:BAC) stock at $7.14.

Add to that approximately $1.6 billion in dividends from Bank of America preferred stock and you get a nice round number for Buffett and the rest of the Berkshire Hathaway shareholders to celebrate over. The Oracle of Omaha strikes again.

Bank of America
Source: Shutterstock

Now the bank’s largest shareholder with 6.6% of Bank of America stock, the question becomes what’s in it for those of us on the outside, looking in? Is Bank of America going to be one of Berkshire Hathaway’s core holdings or is Buffett going to cut and run at the first sign of trouble?

The Dividend is Key

The decision to exercise the warrants all came down to Bank of America’s annual dividend.

If the dividend rate on Bank of America common stock – now 30 cents annually – should rise above 44 cents before 2021, we would anticipate making a cashless exchange of our preferred into common,” stated Buffett in his 2016 letter to shareholders. “If the common dividend remains below 44 cents, it is highly probable that we will exercise the warrant immediately before it expires.”

Lo and behold, Bank of America announced July 26, an increase of four-and-half cent increase in the quarterly dividend putting the annual rate over the 44-cent hurdle.

Cha-ching!

Berkshire Hathaway’s quarterly haul from BAC just increased by 60% to $84 million from $52.5 million before the dividend hike, an increase that all shareholders will receive September 29, as long as they were shareholders by August 29. It’s why Berkshire Hathaway exercised its warrants on the very same day.

Can shareholders expert future dividend increases as high as the latest one? No, I don’t think they can. Here’s why.

Bank of America’s payout ratio is just 21.6% after the 60% dividend hike and well below its peers based on 39 cents paid out in dividends in 2017 against a 2017 EPS estimate of $1.81. Once the 12-cent dividend kicks in for an entire year, the payout ratio jumps to 26.5%, closer to the 34% payout ratio of the KBW Bank Index.

So, let’s assume that BAC gets the green light from the Federal Reserve to increase the payout ratio to 34%. Based on the earnings estimate two years out of $2.47, Bank of America’s got nine quarters to raise the quarterly dividend from 12 cents to 21 cents.

My gut tells me that Bank of America won’t go any higher than a 30% payout ratio which works out to 18-and-half-cents or an increase of almost 5% per quarter.

Such a move would add $45.5 million per quarter to Berkshire Hathaway’s coffers. It’s a huge incentive for Buffett to stick around until the end of 2019.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.

Bottom Line on Bank of America Stock

Personally, I see Bank of America continuing to deliver for income investors including Warren Buffett over the next 12-24 months.

However, with all the gains Bank of America stock has made over the past five years up 21.8% annually, I’m a lot less certain about its ability to deliver capital appreciation anywhere near its recent performance.

Buy Bank of America stock for income, not capital appreciation.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2017/09/bank-of-income-stock/.

©2024 InvestorPlace Media, LLC