Tuesday, November 06, 2007

Bank of America: Dividend Growth Will Continue and the Price Looks Right

Many readers have asked that I show the Dividend Valuation Model for Bank of America. The company recently announced disappointing earnings and has seen it price fall off with the other big banks.

Having said this, I believe the bank is dealing with its issues in investment banking and will be one of the first big banks to get its writedowns behind it.
The current dividend yield is 5.5%. BAC has raised it dividend in each of the last 20 years. Dividend growth, during that time, has averaged nearly 13%, and nearly 15% over the last 5 years.

The past is no guarantee of the future, but I believe the company will continue to increase dividends, albeit at a slower pace.

Wall Street analysts are now estimating that BAC's earning over the next 3-5 years will average near 8%. The chart above uses 8% dividend growth in 2008.

The green candy cane at the far right of the chart is the implied value of BAC at this 8% dividend growth rate. That price is $56 per share.

No one knows the magnitude of the subprime loan problems that lurk in bowels of banks today, but we can make some simple observations. Unless the US economy falls off a cliff, the banks have enough capital to withstand a lot more trouble that the subprime problems appear to present. BAC's management has a reputation for being straight talkers. They did not sugar coat their writeoffs, and CEO Lewis said the performance was unacceptable and that changes were coming in the investment banking group.

By the swiftness of the subsequent actions, the plans must have already been underway on the day of the earnings announcement, because three weeks later they have already replaced many of the top managers of investment banking, and announced the elimination of 3,000 jobs.

Including dividends, if BAC reaches $56 per share over the next 12 months, that will represent nearly a 29% total return.

I admit that it doesn't seem possible in light of the news of the day, but, as I said earlier, if Fed does its job and the economy has even modest growth, the subprime fiasco will gradually fade from the headlines, which will allow the banks to move higher.

I own BAC and have for many years. At 5.5% dividend yield, it doesn't take much price appreciation to make a double digit return. That might look pretty good a year from now.

If you are not a client of DCM, please do not act on my discussion here alone. Consult your own financial advisor.