I’m adding shares of Bank of America (BAC) to my Dividend Portfolio today.
The stock yields only 1.2% on trailing 12-month dividend payments so why am I adding it to a portfolio dedicated to beating the yield on the 10-year Treasury bond?
Because Bank of America has three things going for it at the moment.
First, even before rising interest rates have really kicked in, the bank has been seeing a big increase in net interest income as the spread widens between what the bank pays on the short-term paper that it uses to raise capital and what the bank receives in interest on its long-term loans. In 2017 the bank saw net interest income rise 8.7% and projects that the next 100 basis points in higher interest rates–certainly a possibility if the Fed raises interest rates 3 more times in 2018 and if inflation continues to creep upwards–would boost net interest income by $3.3 billion over the next 12 months. Add in solid growth in consumer banking revenue (10%) and improving margins as credit quality improves and charge offs fall (after increasing in 2017 from 2016) and I can see a 30% increase in earnings in 2018 from 2017
Second, the bank will see a big drop in its corporate tax rate to 20% from almost 30% in the fourth quarter of 2017, thanks to the Tax Cuts and Jobs Act passed by Congress in December. That makes a good part of the earnings improvement a very low risk proposition since the bank doesn’t need markets or the economy to move in any particular direction to pick up the gains from a lower tax rate.
Third, the bank will have plenty of capital to pass the next round of stress tests from the Federal Reserve in June–and that will allow the bank to increase, again, it’s dividend payout. Bank of America increased its 12-month dividend rate to 48 cents a share from 30 cents a share last August after it passed the Fed’s stress test. It’s extremely like that the bank will raise dividend rates again this coming summer after it passes the next stress test. Standard & Poor’s estimates a 30% to 40% increase in the dividend, which would bring the annual dividend to a range of 62 cents to 67 cents a share. I think that might well be a bit low but on S&P’s projection the dividend yield would climb to 1.9% to 2.1%.
That would go a long way to closing the yield gap with the 10-year Treasury, which currently pays 2.65%. On a total return basis, I don’t think the contest would be even close since I expect the price of the 10-year Treasury to continue to fall in 2018 as the Treasury issues a big bulge in bonds and as the Fed continues to reduce the size of its Treasury portfolio and since I expect the share price on Bank of America to hit $37 a share within the next 12 months. The stock closed at $31.94 on January 22.
My first 12 days of Christmas Pick for 2018 was Amazon (AMZN). My second was Nektar Therapeutics (NKTR). The third was Southern Copper (SCCO). The fourth was Nvidia (NVDA) The fifth was Applied Materials (AMAT) The sixth Starbucks (SBUX). The seventh McDonald’s (MCD) (And yes, I missed the deadline of January 5 for the end of the 12 days of Christmas.)