Value investors are attracted to dividends for a few reasons. For one, they provide cash flow. Secondly, they are usually offered by companies that can only afford them; those that cannot but still offer dividends are great indicators of stocks to avoid. Thus dividends, when measured against free cash flow, can be a great barometer of a company’s health.
Additionally, value investors like dividend growth because they provide a growing income source that provides value investors with a greater cash stream while holding an appreciating investment. Value investors look at dividend payout ratios and dividend payout histories to determine how much income their investment is likely to provide now and in the coming years.
In the financial sector, investing in dividend growth was pretty easy until 2008, when dividends were slashed or abandoned entirely. Many financial firms have been recovering, promising dividends and dividend growth to investors as they and the broader economy recover and restructure.
Some banks have been more successful than others in returning to a path of steady dividend growth. Bank of America (BAC) spent five years paying a penny-per-quarter dividend that was more symbolic than valuable, after 16 years of double-digit dividend growth. By 2008, the 64 cent quarterly dividend was providing about a 6% yield.
Part of that yield came from the stock’s falling price, which lost over 80% of its value in 2008. The fall was justified—the dividend was cut 98% and only started to rise 5 years later, but was still 92% below its peak in 2008.
The chart above shows the rate of dividend growth from 1993 to 2013; the steep fall in the financial crisis obscures everything else; however, extended that chart to today creates a different effect:
Here we see the huge increase in dividends last year, when the payouts went from 1 penny to 5 cents. The stock currently yields 1.3%. (You can get an entire history of the company’s dividends on their website.)
With this rise beginning, value investors can now consider BAC as a possible dividend growth candidate. If it is on the cusp of dividend growth, value investors might want to look closely at the company’s dividend payout ratio and its dividend growth history to determine how dividends are likely to trend in the future.