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The coming week will be critical for big banks and investors should take note. Today, the Federal Reserve will release its annual report on U.S. banks' health as prescribed by Dodd-Frank. Based on those results, on March 26, the Fed will tell banks how much they can return to shareholders via dividends and stock buybacks.
Expect the news to be favorable. As a result, dividends from the biggest banks are set to surge. That could likely lead to an upward move in the stock price in the coming months. And dividend increases will be substantial. Analysts expect the dividend payout ratio to increase from 24% of net income to 26% of net income. Still, despite the increase, the payout ratio remains well below the 44% level that occurred during the year ending March 31, 2009. But that just illustrates the continued increase in dividend payouts that could continue years to come.
I have said for a while now that owning these financials today continues to remain a good choice. And one of my favorite picks still remains Bank of America (BAC). In the past, Bank of America's plan to increase its dividend has been rejected by the Fed. But Bank of America continues to get healthier: Its Tier 1 common ratio, a key metric the Fed uses to gauge financial health, increased to 10% as of year-end 2013, up from 9.3% in the prior year.
Bank of America's dividend has remained at $0.01 per share per quarter since the financial crisis. Several analysts expect the dividend to be increased to $0.10 per share. Bank of America's stock price of $17.40 is up more than three fold since the market bottom of March 2009. If Bank of America's dividend increases to $0.40 per year, those who bought shares for $5-$6 share will enjoy a tidy 6.6% to 8% yield based on that price. Two years from now, the dividend yield could exceed 12% for those who bought in during that period. Don't discount the value of dividends, especially growing ones, and their exponential return value over time.
Other banks expected to see substantial jumps in the dividend payouts are Citigroup (C) and Morgan Stanley (MS), while names like Wells Fargo (WFC) and JPMorgan (JPM) have already benefited from Fed clearance to raise the dividend in years past. Even at the current market valuations, financial stocks as a whole trade at meaningful discounts to the market multiple -- and they still possess catalysts to enhance shareholder value.
Editor's Note: This article was originally published at 2:30 p.m. EDT on Real Money on March 20.