Last month, Bank of America Corp (NYSE:BAC) gave shareholders some very good news.

Thanks to passing its so-called “stress test” administered by the Federal Reserve, it would be allowed to generously give capital back to shareholders via a combination of higher dividends and a pretty significant stock-buyback program.

BofA has authorized the repurchase of $12 billion worth of BAC stock within the next 12 months, and it aims to ramp up its dividend payout to 48 cents per share by next year as well.

It’s a tremendous step forward. Not only is that the biggest buyback program the company has initiated in years, but that 12-cent quarterly check will be Bank of America’s biggest per-share payout since the 2008. That’s when the sub-prime meltdown forced the company to slash its payout to the bone.

It does beg the question, though: Can BofA actually afford to return this much capital to investors?

The Stress Tests

The aforementioned stress test, for those not familiar with them, are the Fed’s way of ensuring that a repeat of 2008’s banking implosion never happens again.

Most of the major bank names — including Bank of America, Wells Fargo & Co (NYSE:WFC) and Citigroup Inc (NYSE:C) — were all caught with their proverbial pants down in 2008. Each was undercapitalized for the economic fallout from the mortgage meltdown that year.

The Federal Reserve’s stress test applies a rather harsh “what if” scenario to see — above all else — if the nation’s banks would need a bailout should the worst-case scenario pan out. If the answer is no and a bank exceeds the minimum threshold, that excess capital can be doled out to shareholders.

Bank of America passed its most recent stress test with flying colors, giving it the green light to increase its payout. The bank aims to do just that, growing its dividend on BAC stock to 12 cents per quarter within the foreseeable future — a feat at least made partially possible by $12 billion worth of stock repurchases.

Numbers Don’t Lie

What would that look like, though? How close would Bank of America be “cutting it?”

There’s a chart that tells the tale, although it requires a couple of caveats before reviewing it.

  • The graphic is largely based on analyst assumptions regarding earnings.
  • While analysts have opined estimates about the amount of BAC stock that will be outstanding one year, two years and even three years down the road, nobody really knows what that tally will be. Bank of America has authorized sizable stock-buybacks every year since 2013, but it’s also issuing shares at the same time. In fact, an authorized buyback is anything but an outright requirement.

Be that as it may, the collective wisdom of analysts is still the best guess we’ve got, and we should use it as our most likely look ahead.

With that as the backdrop …

At first glance, affordability isn’t a issue in the sense that the bank’s GAAP and non-GAAP earnings will still far exceed what it’s giving back to BAC stock owners.

On the other hand, with the payout ratio approaching 30% versus 2016’s payout of less than 17%, it’s not out of line to start asking questions about the wisdom of such generosity.

Don’t misunderstand. Plenty of companies give back way more than 30% of their profits to shareholders in the form of dividends. In that light, BofA’s payout plans don’t look all that different than its peers’ plans.

It’s also worth noting Bank of America is far more likely than not to top its earnings estimates; analysts are probably underestimating the company’s future financial strength.

Bottom Line for BAC Stock

A wide swath of the projected dividend ramp-up stems from the stock buyback. Net income is expected to only grow 22% this year, and 24% next year, trailing the expected dividend growth of 52% and 43%, respectively. Still, the bank’s capital return program – generous as it may be — is also plenty affordable as well as quite plausible.

Sure, an outright economic headwind might put the kibosh on the bank’s mission to share more of the wealth. There’s not such a headwind on the horizon though.

In other words, there’s no reason to suspect Bank of America is overpromising and setting itself up to underdeliver. That’s fantastic news for anyone holding BAC stock.

— James Brumley


Source: Investor Place