This Play on American Banks Just Keeps Getting Better

Shareholder distributions from American banks are about to skyrocket.

Why does that matter to us here at Wealthy Retirement?

Because right from the bottom of the COVID-19 crash last spring, we have been pounding the table on bank stocks.

It took a bit of time for Mr. Market to agree with us, but our call on the banks has delivered. Financial stocks have thrashed the market since last spring.

It has been a great time to own the banking sector, and the good times aren’t over.

Recently, the U.S. Federal Reserve released the results of its latest “stress test” on the U.S. banking sector. The stress test is designed to show whether or not each bank has the financial stability to withstand a major global recession.

All 23 of the major U.S. banks passed with flying colors.

With these results, shareholders of U.S. banks are going to be well rewarded.

Last June, the Fed imposed limits on how much banks could return to shareholders through dividends and share repurchases.

(As Chief Income Strategist Marc Lichtenfeld pointed out in yesterday’s article, share buybacks are often a bad omen for stock performance. In the case of my favorite bank stock, I believe share buybacks will benefit shareholders because bank valuations are cheap. More on that in a moment.)

The goal was to make sure the banking system stayed strong so that it could support an economy weakened by COVID-19.

With bank balance sheets in incredible shape and the economy recovering quickly, the Fed is now removing those restrictions.

That means the amount of cash that U.S. banks are distributing to shareholders is about to increase.

Wells Fargo Just Announced a Huge Cash Return

My absolute favorite bank stock over the past year has been Wells Fargo (NYSE: WFC).

In early October, I wrote about the stock’s then insanely cheap valuation.

At that time, the total market valuation for Wells Fargo had dipped to just $90 billion.

Against that entry price, the cash returns that Wells Fargo shareholders are about to receive over the next year are incredible.

With the Fed lifting payout restrictions, Wells Fargo has indicated that it intends to return more than $21.3 billion to shareholders over the next 12 months.

That $21.3 billion will be split as follows:

  • $3.3 billion in dividends
  • $18 billion in share buybacks.

For those of you who were buying shares at $22 with a $90 billion stock market valuation, it means you are now earning an annual cash payout from Wells Fargo of 23.6%. These huge share buybacks are going to dramatically reduce the number of shares Wells Fargo has outstanding.

With Wells Fargo’s current share price near $45, a total of $18 billion in buybacks will reduce Wells Fargo’s share count by 10% in just 12 months.

For share repurchases to be a good idea, they have to be done when a company’s shares are attractively valued. Given that Wells Fargo can reduce its share count by 10% in just one year, we know that the company is getting a good deal.

When it comes to share buybacks, a company should think like an investor. That means buying low and selling (issuing shares) high. That is exactly what Wells Fargo and the banking industry are doing.

With these buybacks, Wells Fargo’s share count will drop from 4.1 billion shares to 3.7 billion shares.

To appreciate how powerful this share count reduction will be, consider that Wells Fargo is expected to earn $20 billion next year.

With 4.1 billion shares outstanding, $20 billion in earnings equates to $4.87 in earnings per share.

(Remember, it is always earnings per share that matters to us as investors.)

After a year of buybacks, at the reduced 3.7 billion share count, the same $20 billion in earnings equates to $5.40 in earnings per share, which is 11% higher.

That means with just one year of share repurchases, Wells Fargo will have created 11% per share earnings growth even if total earnings don’t increase.

And Wells Fargo has the earnings power to buy back this amount of stock every year! That means double-digit earnings per share growth just because of the buybacks alone.

At this pace, Wells Fargo could repurchase every outstanding share in just 10 years, assuming that earnings stay constant.

If you will recall from my earlier pieces on Wells Fargo, I believe there is significant earnings growth coming.

Wells Fargo’s management has indicated that it expects to drive $8 billion of earnings growth in the coming years by bringing the company’s expenses in line with those of the rest of the industry.

And if interest rates start rising, driving wider lending margins, Wells Fargo’s earnings will increase even more.

Wells Fargo has already been a big winner – and with the cash returned to shareholders exploding higher, this ride on the American banking sector is going to just keep getting better.

Good investing,

— Jody

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Source: Wealthy Retirement