BAC is Banking on a Strong Economy

Summary:

  1. Bank of America benefited from the solid economic situation in the United States.
  2. The Consumer banking and Wealth Management Divisions are steady growth vectors.
  3. The bank has shown its ability to grow its revenue while controlling its expenses.

We started the most recent earnings seasons with several results coming from the financial sectors. Among them, investors had the chance to receive some substantial pay check raises. BlackRock (BLK) raised its payout by 8.7% and Wells Fargo (WFC) raised it by 12%. The most impressive increase came from Bank of America (BAC) with a 25% increase. Surfing on a strong US economy, BAC has posted a solid quarter. Is it time to buy some shares? Let’s take a deeper look!

Understanding the Business

Bank of America Corporation is a bank holding and a financial holding company. The company provides financial products and services to people, companies and institutional investors. The company shows over $1 trillion in assets and has the most consumer deposit share in the U.S. BAC Consumer Banking division. It represents 38% of its net income, 32% for Global Banking, 15% for Global Markets and 15% for Global Wealth and Investment management.

Source: BAC investors presentation

A Look at Their Latest Quarter

On July 16th, BAC reported the following results:

Non-GAAP EPS of $0.63, up by +37%, beat estimates by $0.06.

Revenue of $22.61B, down by -1%, beat estimates by $340M.

Dividend of $0.15/share, +25% increase.

What the CEO said:

“Responsible growth continued to deliver as a driver for every area of the company. We grew consumer and commercial loans; we grew deposits; we grew assets within our Merrill Edge business; we generated more net new households in Merrill Lynch; and we supported more institutional client activity — all of this while we continued to invest in our businesses and began an additional $500 million technology investment, which we intend to spend over the next several quarters, due to the benefits we received from tax reform.”

Growth Vectors

Source: Ycharts

Thanks to its size and strong customer service, BAC has a dominant position in the banking landscape in the U.S. As interest rates are rising, BAC deposits will earn additional income and the spread between loans and savings should improve its margins.

Another aspect I like about BAC is its growing presence in the mobile banking business. Pretty much everything we do is moving into our phone lately. If you can do your grocery shopping, buy a new swimsuit for your kid, and organize your wedding online, you might as well do all your banking. BAC is investing massively to position itself as a strong player in this new playground. With over 25 million clients in its digital sales, BAC is doing something good!

Souce: BAC Q2 2018 Investors Presentation

Dividend Growth Perspective

We all know what happened in 2008 and what it did to banks across the world. This is how BAC had to cut its dividend back then and it is slowly coming back on the dividend investors radar. The stock is pretty far away from making the Dividend Achievers List.

Source: Ycharts

After what happened in 2008, there has been a complete revolution in the US banking system. The Government saved banks but added more regulations. BAC is still very far from its $0.64/share policy back in 2008, but we can see a strong growth in the past 5 years. While not an Achiever yet, BAC is making our list of the top financial dividend stocks.

Source: Ycharts

Now that the Government is restraining the bank’s dividend policy, you can count on sustainable payouts for several years to come.

Potential Downsides

When a bank becomes too big, loopholes start to appear, and management could quickly lose grip on its business. We can think of what happened at Wells Fargo not too long ago.

Also, BAC has gone through a serious cost cutting program that boosted earnings for a while. Now that the company is leaner, management will have to find other ways to improve their bottom line.

While BAC puts lots of emphasis on its digital services, other Fintechs are growing rapidly to grab big banks’ market shares in various sub-sectors.

Valuation

After its stock more than doubled between 2016 and 2018, BAC shares are relatively stable since the beginning of 2018. Is it time to pick some shares while it is stuck in a plateau?

Source: Ycharts

As you can see on the PE graph, the right timing to catch some shares was in 2016 while the stock was trading at its lowest PE ratio in 10 years. While BAC doesn’t seem too overvalued right now, it doesn’t like a bargain either.

I’ve used the Dividend Discount Model to establish a fair value. I’ve used a 12% dividend growth rate for the first 10 years as I believe the bank will continue to surf on a strong economy and other raises similar to 2018’s will happen in the next few years. After that, I reduced the growth rate at 6% which is more in line with what a classic bank (notably Canadian banks) are doing.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $0.48
Enter Expected Dividend Growth Rate Years 1-10: 12.00%
Enter Expected Terminal Dividend Growth Rate: 6.00%
Enter Discount Rate: 9.00%
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $50.99 $33.41 $24.65
10% Premium $46.74 $30.62 $22.59
Intrinsic Value $42.49 $27.84 $20.54
10% Discount $38.24 $25.06 $18.48
20% Discount $33.99 $22.27 $16.43

 

Please read the Dividend Discount Model limitations to fully understand my calculations.

Unfortunately, a great entry point would be between $25 and $28. As BAC trades around $30, there is no deal here.

Final Thought

While BAC is a strong play in the U.S. banking industry, I think investors missed the boat that passed a few years ago. Right now, whether you pick JPM, BAC or WFC, you will be paying about 10% over their value. Better keep them on your watch list!

 

Disclosure: I do hold BLK and WFC in my DividendStocksRock portfolios.

Additional disclosure: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

 

The Evolution of a Stock Price over 30 Years

One way to understand how the stock market works is to look at how it was built throughout time. As a dividend growth investor, I focus on picking shares from strong companies that show several growth vectors. I want to make sure those companies not only paid dividend in the past, but that will also continue to pay and increase it in the future.

I started investing in 2003. This gives me 15 years of investing experience including 2 bull markets and only one crash. I’ve followed the techno crash on my computer while I was working on my bachelor’s degree in finance, but that doesn’t really count as I had no money invested back then.

I remember feeling that my first investments weren’t growing fast enough for me. A high single-digit to low teens return each year didn’t appear that impressive back then. Today, I understand that the path through dividend growth investing is a long hike through the mountains. Sometimes you go up, sometimes you go down. It’s important to take pause and admire the nature. Eventually, you will rise to the top and feel like a king. But that takes lots of time and effort.

I thought of looking at 3M Co (MMM) over the past 30 years to give younger investors a perspective of what is looks like to be a long-term focused investor.

1988 to 1998

  • Stock price on December 31st 1987: $15.52
  • Quarterly dividend: $0.133/share
  • Stock price on December 31st 1997: $41.03 (+164%, 10.19% CAGR)
  • Quarterly dividend: $0.265/share (+99%, 7.12% CAGR)

Source: Ycharts

Founded in 1902, MMM was already an old company in 1988. The 80’s were marked by a very important innovation:  the famous Post-It was created in 1980 and offered in multiple colors in 1985. MMM was getting to enter into the “new world” with its first internet website in 1995. In 1996, the company’s data storage and imaging divisions were spun off as Imation Corporation.

As you can see on the graph, MMM also benefitted from the tech bubble lift-up. Shares went up from mid $20’s in 1995 to close to $50 in 1997. In the meantime, MMM never missed an occasion to reward its shareholders with consistent dividend increase.

1998 to 2008

  • Stock price on December 31st 1997: $41.03
  • Quarterly dividend: $0.265/share
  • Stock price on December 31st 2007: $84.32 (+105%, 7.44% CAGR)
  • Quarterly dividend: $0.48/share (+81%, 6.11% CAGR)

Source: Ycharts

The stock went sideways along the rest of the market going through the tech bubble, the Enron fraud and the World Trade Center attack. In 2004, boosted by several innovations, 3M tops $20B in sales. The company introduces many upgraded products such as Post-it® Super Sticky Notes, Scotch® Transparent Duct Tape and optical films for LCD televisions.

At that time (mid-2000), the stock surges and so is the dividend. While it was a good decade, MMM performances on the market weren’t as good as they were 10 years ago. Is the company done with innovation? Is it a sign MMM will finally slow down? Let’s continue our time travel story…

2008 to 2018

  • Stock price on December 31st 2007: $84.32
  • Quarterly dividend: $0.48/share
  • Stock price on December 31st 2017: $235.37 (+179%, 10.81% CAGR)
  • Quarterly dividend: $1.175/share (+145%, 9.37% CAGR)

Source: Ycharts

2008 arrives and the stock drops back to nearly $40. All of a sudden, 10 years of stock market returns disappear. Thanks to all those dividends, 3M shareholders still have a reason to smile. Nonetheless, new investors don’t find it very funny. However, in 2013, 3M tops $30 billion in sales and the stock is back on track. A year later, 3M registers its 100,000th patent and proves itself as being the innovation company it always been.

Believe it or not, MMM posts its strongest decades in 30 years. Keep in mind the stock lost about 50% of its value in the first 12 months of the decade, and yet, finished 200%+ up if you include dividend payment!

Final thought; stay invested!

Over the last 30 years, both MMM and the rest of the stock market went through many great periods and several challenges. When you look at each graph, you will see how MMM was dead money for a few years and then offer a big boost. A similar trend could be seen with its dividend policy. But overall, MMM posted high-single digit stock return and dividend growth rate for each decade. Long-term investors have passed through all those storms and ended-up with amazing results:

Source: Ycharts

In then end, it doesn’t matter the price you pay; just pick strong companies and they will reward you decades after decades.

 

Obvious disclaimer… long MMM

Is DOC Healthy Dividend is Enough For a Long-Term Treatment?

Summary

  • Physicians Realty Trust evolves in a growing market (healthcare).
  • This REIT pays a 6% yield and focuses on quality tenants.
  • But where is the dividend growth?

There is no doubt the Healthcare sector is a growth sector for the upcoming decade. As the population ages in the U.S., the amount spent on healthcare will skyrocket. The CMS projects a 63% increase in healthcare expenditures during the next 10 years. DOC is well positioned with its growth-by-acquisition strategy. DOC has focused on tenants’ quality and continuously improving its tenants grade. Between 2015 and 2018, DOC has also reduced the weight of its top 10 tenants from 34% to 27%.

Now that DOC shares have tumbled by almost 20% ytd (-17% as of May 15th), is this 6% yield REIT worth your attention?

Understanding the Business

As the name suggests, DOC is a self-managed healthcare real estate investment trust that acquires, owns, and manages healthcare properties that are leased to physicians, hospitals, and healthcare delivery systems and other healthcare providers. You can download the complete list of solid dividend paying REITs here.

Their properties are likely to be on campus with a hospital or located nearby with partnerships in place. DOC currently manages 280 properties worth about $4.3B. 96.6% are leased with an average contract term of 8.3 years.

Source: DOC investors presentation

DOC shows a great geographic diversification with properties in 31 states and only one (Texas) representing more than 10% of its portfolio (14%). This enables DOC to reach a maximum population potential without cannibalizing its own offer.

Source: DOC investors presentation

Growth Vectors

Source: Ycharts

DOC shows an impressive growth profile over the past 5 years. The company quickly positioned its business through various acquisitions while maintaining a healthy balance sheet. Its revenue plainly skyrocketed during that period. DOC will continue to surf on the same tailwind (aging demographic) for another decade.

Source: DOC investors presentation

It’s obvious that DOC wanted to position itself as a leader in this industry. The main advantage with Real Estate is that once DOC builds (or buys) a healthcare property and links it to a hospital, it is very hard for a competitor to build a new one right beside it. This is a first mover advantage in this business and DOC jumped on the occasion.

Dividend Growth Perspective

When you look at DOC’s dividend history, you will not be flabbergasted. We are talking about a company that paid its first dividend in 2013 and increased it only once in the past 3 years (+2.22%). We are far from talking about a Dividend Achiever here. You can download complete list of stocks with 10+ year dividend growth here.

Source: Ycharts

We have used a 2% dividend growth rate for our DDM calculation, but keep in mind this doesn’t reflect the current situation. In other words, DOC pays a yield around 6% and this is what you are going to get from this REIT. Don’t expect much else.

Potential Downsides

There are many changes around the healthcare system and it is still unclear on how those modifications will affect businesses evolving in this playground. DOC grew very fast over the past 5 years and now that interest rates are rising, this will affect future profitability. The company currently shows a dividend payout ratio (based on FFO) of about 90%. While the payout is safe due to a healthy business, this doesn’t leave much room for increases. Once debt matures and need to be renewed at a higher rate, the dividend perspectives will not improve. Keep in mind that if your dividend payout doesn’t increase, your buying power shrinks year after year. For your retirement plan, you should consider an inflation rate of 2%. Therefore, any stocks showing less growth perspective are hurting your portfolio and reducing your retirement budget.

Valuation

Now that the stock has dropped by almost 20% in 2018, maybe it’s time to take a second look at DOC fair valuation. Since using the PE ration history isn’t very useful when looking at REITs, we’ll focus on the dividend discount model.

As previously discussed, we used a 2% dividend growth rate to match the inflation. Unfortunately, this is not the case at the moment. Therefore, if DOC can’t show any upside potential now (fair value at $13.41), there is not much appeal to invest in DOC.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $0.92
Enter Expected Dividend Growth Rate Years 1-10: 2.00%
Enter Expected Terminal Dividend Growth Rate: 2.00%
Enter Discount Rate: 9.00%
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $18.77 $16.09 $14.08
10% Premium $17.20 $14.75 $12.90
Intrinsic Value $15.64 $13.41 $11.73
10% Discount $14.08 $12.07 $10.56
20% Discount $12.51 $10.72 $9.38

Final Thought

Please read the Dividend Discount Model limitations to fully understand my calculations.

While the sector and tenant profile are interesting, DOC’s dividend perspectives are deceiving. It would become a buy if DOC shows the ability to grow its distribution to match inflation. At this time, there are too much uncertainties around the healthcare industry in the U.S. and DOC doesn’t pay us enough to wait. I understand the 6% yield looks appealing, but it’s nothing if the payment can’t increase in the future. With a 90% FFO payout ratio, there is little room for this scenario.

Disclaimer: I do not hold DOC in my DividendStocksRock portfolios.