Many investors have been caught off guard in the ongoing bear market and are therefore wondering how they should position their portfolios. Rising inflation to a 40-year high is putting a lot of pressure on many companies’ margins, but few sectors are actually benefiting in the current environment.
Of course, banks benefit greatly in the current environment of rising interest rates as they enjoy much wider net interest margins, i.e. the difference between the interest they charge on their loans minus the interest they pay on their deposits.
Below we discuss the outlook for three banks that offer dividend yields above 4%.
Connect this USB
Founded in 1863, US Bancorp (USB) has grown from a regional bank to a national powerhouse in recent years, becoming the fifth largest bank by assets in the US. It mainly focuses on traditional banking activities, but also offers wealth management, payments and investment services.
Minneapolis-based US Bancorp’s primary competitive advantage is its outstanding performance record, which has resulted primarily from its exemplary management team. The company operates as a regional bank, but on a massive scale, and as such has proven much stronger during the downturn than its larger peers. Indeed, while many banks struggled to survive during the Great Recession, US Bancorp’s profits fell by less than 50%, and the bank came out of that recession much stronger than most of its competitors.
It’s also important to note that US Bancorp grew its earnings per share every year from 2009 until the pandemic hit in 2020. That’s an excellent performance record. The bank has grown its EPS by an average of 6.7% per year over the past decade. While US Bancorp will struggle to match the record earnings per share of $5.10 it posted last year, it’s still on track for its second-best performance this year.
Additionally, since US Bancorp is more focused on traditional banking services, it benefits more than many banks from rising interest rates. As long as interest rates remain high, US Bancorp will continue to thrive.
Additionally, US Bancorp has raised its dividend for 11 consecutive years and currently offers a dividend yield of 4.4%. Given its healthy payout ratio of 44% and proven resilience to downturns, the bank is likely to continue raising its dividend for many years to come. The company has increased its dividend by an average of 10% per year over the past decade and over the past five years. Given all of these attributes, it’s clear that US Bancorp is an attractive candidate for income-oriented investors.
A Dividend Ally
Ally Financial (ALLY) provides financial services to consumers, businesses, auto dealers and corporate clients. Its services include term loans, lines of credit, fleet financing, vehicle financing and commercial insurance products. It is also notable that the bank’s offerings attract many millennials. This bodes well for the company’s growth prospects.
Ally Financial was bailed out during the Great Recession. After the bailout, the company was listed again in 2014 and therefore has a short history. Its bankruptcy in 2009 and short performance increase the stock’s inherent risk.
On the bright side, Ally Financial has grown its earnings per share significantly, from $1.36 in 2014 to an expected $6.00 per share this year. Just like US Bancorp and Citigroup (see below), Ally Financial posted record EPS of $8.60 in 2021 thanks to the economy’s strong recovery from the pandemic and subsequent reversal of loan loss forecasts. Since this tailwind is not recurring, the bank is unlikely to be able to match its record performance anytime soon.
On the other hand, Ally Financial benefits greatly from the Fed’s aggressive rate hikes, as this policy boosts the bank’s net interest margin. This is clearly reflected in the results of Ally Financial, which is on track for its second best performance this year.
It’s also worth noting that Ally Financial is extremely shareholder-friendly, offering a generous dividend yield of 4.6% while also repurchasing its shares at a brisk pace. Since 2014, the bank has reduced its share count by 4% per year on average. In addition, the stock offers a high dividend yield of nearly eight years with a steady payout ratio of 20%. As such, its dividend appears to have a large margin of safety in the absence of a prolonged recession. However, investors should always keep in mind that this bank is vulnerable to economic downturns.
Go to Citi
Citigroup (C) was founded in 1812 and has grown into a global juggernaut in credit cards, commercial banking, trading and a variety of other financial activities. Citigroup is not as tied to traditional lending as most other banks. Its competitive advantage lies in its global reach and its strong position in the lucrative credit card industry.
Citigroup would have been a much bigger bank, but suffered excessive losses in the Great Recession, the worst financial crisis in 90 years, in 2009. The bank found itself caught off guard in this crisis and had to be restructured. As a result, its shareholders suffered catastrophic losses. To put that in perspective, the stock has recovered from its bottom in that recession, but still trades about 90% below its pre-crisis levels in 2007.
Fortunately, Citigroup seems to have learned its lesson from this downturn. Thanks to the favorable business environment for financial companies, Citigroup is on track to post EPS of around $8.20 this year. That would mark its second-best performance since the Great Depression.
Its best performance was in 2021, with earnings per share of $10.07, but it will be difficult for the company to repeat such performance given the excessive non-recurring loan loss reversals recorded that year thanks to the economy’s recovery from the pandemic. However, if Citigroup meets our expectations this year, it will have grown its EPS by an average of 7.8% per year over the past decade. This is certainly a satisfactory growth rate, although investors should be aware that there is considerable volatility in the bank’s performance.
As long as interest rates remain relatively high and the economy does not fall into a severe recession, Citigroup is likely to continue to thrive thanks to the aforementioned effect of high interest rates on the bank’s margins. On the other hand, the company is likely to struggle to grow earnings from this year’s high base of comparison. However, the market has already priced that into the stock, which recently traded at an extremely low price-to-earnings ratio of 6.0, a near 10-year low.
Additionally, Citigroup currently offers a dividend yield of 4.2%. The company has kept its dividend steady for three straight years, so it flies under the radar of most income-oriented investors. On the other hand, it has a payout ratio of only 25% and hence its dividend has a significant margin of safety for the foreseeable future.
The rise in inflation this year has put pressure on many companies due to the increased costs incurred and the impact of rising interest rates on most companies’ interest expenses. However, as long as a severe recession does not occur, banks appear to be a bright spot as they enjoy much higher net interest margins, which more than offset the impact of rising loan loss provisions.
The three banks above currently offer above-average dividend yields, with a significant margin of safety. Among the three banks, US Bancorp appears to be the most attractive due to its exemplary management, solid performance history and superior resilience during the economic downturn.
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