CKBlog: Strategies
Wednesday, November 20, 2019
Bank Stocks are Like Rental Properties
by Steve Haberstroh, Partner
Owning rental property is generally viewed as a terrific investment. It’s hard to argue with the rationale. When executed properly, you collect cash while someone else pays down your mortgage, allowing you to build equity. All this while you sleep (until that 3 a.m. call to fix the toilet of course).
If collecting checks and building ownership sounds pretty good but you don’t consider fixing toilets as one of your hobbies, maybe you should check out bank stocks. Sounds crazy right? Hang on.
The purpose of this post isn’t to give specific stock recommendations. Nor am I suggesting you sell your rental property. But it seems investors have started to “like” banks again and I believe something called “shareholder yield” has something to do with it. And since the concept can be confusing, I’m likening it to owning a rental home.
Shareholder Yield
There are several technical definitions of shareholder yield. The simplest, and the one I am using here, is the combination of a company’s dividend yield and its share buy back ratio. Stay with me here!
Dividend: a sum of money paid regularly (typically quarterly) by a company to its shareholders out of its profits or reserves. (Oxford Dictionary)
Share Repurchase (aka Buy Back): a transaction whereby a company buys back its own shares from the marketplace ... A share buyback reduces the number of outstanding shares … (Investopedia)
The benefits of receiving dividends is clear. Many investors enjoy earning cash while owning stock. Share buy backs, however, can be a bit more complex. So I’d like to turn to famed Investor Warren Buffett (as I often do) to help explain. From his 2019 Letter to shareholders: “When a stock can be bought below a business’ value, it probably is its best use of cash ... If Charlie (Munger) and I think an investee’s stock is underpriced, we rejoice when management employs some of its earnings to increase Berkshire’s ownership percentage.”
Ok, so an owner of stock could collect income AND increase their ownership in the company by sitting around doing nothing. Combine the two of these, and you have? You guessed it: shareholder yield!
Ok, so where can I find such a thing?
Banks as Rental Properties
In the aftermath of the financial crisis, US banks were restricted from issuing dividends or buying back stock until the Federal Reserve felt their balance sheets were strong enough to do so. The so-called “Stress Tests” were performed annually and it wasn’t until 2011 that banks began to substantially increase their dividend payout and buy-back programs (shareholder yield).
It took some time, but many banks now sport dividend yields above the S&P 500 Index. As I type this, JP Morgan has a current dividend yield north of 2.5% while the S&P 500 Index sports a 1.76% yield. That means if you own $1,000 of JP Morgan stock, each year you collect roughly $25 in cash —cha-ching!
But that’s not all! During the year, you also would have collected more ownership of the bank just by doing nothing. JP Morgan has been buying back a ton of its own stock. In its 2018 Annual report, JP Morgan’s CEO Jamie Dimon pointed out that in the prior five years, the company bought back 20% of its shares!
An investor in JP Morgan stock not only collected dividends in those five years, but their ownership in JP Morgan also increased by 20%. This while never touching—err I mean—never fixing a toilet! Shareholder yield never felt so good!
But JP Morgan isn’t the only bank that has a healthy dividend and is buying back a lot of stock. Let’s look at the shareholder yield of the top banks in the US. Remember, shareholder yield is the combination of a stock’s dividend yield and its buy back ratio.
Data as of October 31, 2019 sourced by Bloomberg.
The average shareholder yield on the top US Banks is north of 10%. So it should come as no surprise that the top shareholder of Bank of America, Wells Fargo, and Bank of NY Mellon is Warren Buffett’s Berkshire Hathaway. He’s never been shy about his love for cash flow and share buy backs.
If shareholder yield is getting you all fired up, you aren’t alone. The S&P Bank Index (ticker KBE) is up +25.20% year to date through November 15th. Will it continue? Who knows. But like rental properties, owners of bank stocks can collect cash (and ownership) while they wait.
I am not suggesting you go sell your investment property and buy a bunch of bank stocks. But if collecting checks and increasing ownership while doing nothing is your thing, you might understand why Buffett and many others own bank stocks.
Sure as a bank owner, you’d have to pay attention to the seemingly never-ending fines relating to the Financial Crisis, the current interest rate environment, and the move to digital banking. But at least you won’t have to fix their toilets ...