Wells Fargo's Dividend Hike and Stock Buyback Plan Are a Good Start

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Following the recent lifting of restrictions on large bank dividends and stock buybacks, Wells Fargo (NYSE:WFC) announced that it plans to double its quarterly common dividend to $0.20 per share. The bank also announced that its board of directors has authorized an $18 billion stock repurchase plan between Q3 of 2021 and Q2 of 2022. While increases had been expected, many still didn’t know exactly how much Wells Fargo would increase its dividend, or how large the repurchase program would be. But I was happy with the moves the bank made. Here’s why.

Doubling the quarterly dividend

Now, doubling the quarterly common dividend from $0.10 to $0.20 per share is not that big of a jump after Wells Fargo cut its dividend 80% last year. But the raise quickly gets Wells Fargo back to a more normalized range in terms of dividend yield and payout ratio.

Currently trading around $43.50 per share, an $0.80 annualized dividend gives the bank a roughly 1.8% dividend yield, which is still toward the lower end of where its peers are, but much more in line. In terms of payout ratio, analysts on average expect Wells Fargo to generate earnings per share (EPS) of $3.82 in 2021. If this ends up happening, Wells Fargo would have an annualized payout ratio of 21%, which again gets close to the range of most of its big bank peers that tend to have a dividend payout ratio between 25% and 40%.

Image source: Wells Fargo.

Frankly, as CEO Charlie Scharf basically said on Wells Fargo’s first-quarter earnings call, the $0.51 quarterly common dividend was too high relative to peers, and would have resulted in a current dividend yield of 4.7% and a payout ratio of more than 53% based on projected EPS of $3.82 this year. Also, analysts expect EPS to fall to $3.55 in 2022. With that kind of dividend payout ratio and the share repurchase plan, it might have been tough for Wells Fargo to cover all of its capital distributions with its earnings capacity right now.

Additionally, I feel confident that the dividend will continue to grow from here. Scharf has essentially said that he thinks a 30% to 40% dividend payout ratio is appropriate. Earnings should also grow as loan activity picks up, the bank continues to get more efficient, and the asset cap gets removed.

Stock repurchase plan

Some investors may have also been disappointed with the $18 billion share repurchase plan — Wells Fargo authorized a $23 billion stock repurchase plan in 2019.

But with Wells Fargo’s current market cap around $180 billion, if it does repurchase all $18 billion worth of shares, that means it would end up buying back 10% of its outstanding market cap, or another roughly 400 million-plus shares. Shareholders obviously would have loved for Wells Fargo to repurchase shares toward the end of last year, when they traded well below tangible book value (TBV) (equity minus goodwill and intangible assets). That’s because buying below TBV essentially means buying $1 of assets for less than $1. But the Federal Reserve banned share repurchases for much of last year.

But Wells Fargo can still repurchase shares at a good valuation. Currently, the bank trades around 130% TBV, which is well below what most peers and the industry as a whole are trading at, so there is still time to repurchase stock at a good value. Just like the dividend, I am also sure annual share repurchase authorizations will increase as earnings do.

A good start on a longer path

With the dividend yield at roughly 1.8% and the bank planning to repurchase roughly 10% of its current market cap, that’s equivalent to returning 11.8% of Wells Fargo’s market value to shareholders. After past recessions, it typically took a while for banks that cut their dividends to raise them back up to a more normalized level, so I believe the jump to $0.20 is a very solid start. And still with a small payout ratio and subdued earnings, I am sure Wells Fargo’s dividend will keep growing. Ultimately, I think the bank is moving at an appropriate pace as it rebounds from the pandemic. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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