Banks to Buy Back Shares, Raise Dividends After Passing Fed’s “Stress Test”

Several major banks, including most of those deemed “too big to fail,” are set to raise their dividends and announce large stock repurchases after passing the latest Federal Reserve “stress test.”

Banks and financial institutions that have repaid their government bailout TARP funds and passed the stress test have been given the go-ahead by the Federal Reserve to make new capital-based decisions such as increasing their dividend payouts or doing share buybacks.

The-FedShortly after the Fed’s announcement, the financial sector came alive with press releases about how the banking stocks would take advantage of the new allowances.

J.P. Morgan announced both a higher dividend and a share buyback, for example.

Banks Raising Dividends After Drastic Cuts

During the height of the banking crisis, most banks and financial stocks were forced to cut their dividends to minimal levels, or even to zero. Eliminating their dividends took away one of the major reasons to invest in financial stocks, which historically have provided solid dividend income to investors. Even the the financial sector’s best preferred stocks were forced to slash their dividends.

The quick moves by the big banks and Wall Street firms to reverse their dividend cuts offer a glimpse at how the banks themselves feel about their current position in the capital markets.

It is not surprising that the same banks who did not have enough capital to weather the banking crisis now believe that they have enough capital to weather whatever comes next. The interesting part will be how banks choose to implement their newfound regulatory freedom.

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Banks announcing big share buybacks are focusing their efforts on raising their stock prices. Buying back shares reduces the number of outstanding shares and theoretically, causes stock prices to rise by lowering the available supply of bank stock shares.

Banks announcing higher dividends are focusing on returning to their position as high dividend-paying stocks. This action suggests that the company is comfortable in their long-term revenue and balance sheet position. Unlike a share buyback, which is only a one-time authorization to repurchase shares, not a commitment, an increased dividend is an on-going capital commitment.

Cutting a dividend requires a high-profile announcement and is generally regarded as both bad news and a sign of bad management. As such, companies are very careful to only raise dividends when they are confident that they will be able to continue paying them.

Banks Good Investment With Higher Dividends?

Are banks stocks a good investment now that they will be paying higher dividends and repurchasing shares?

For financial stocks that lean more heavily to share buybacks, the message is mixed. A share buyback demonstrates that management is focused on the stock price, which can be a good thing. However, short-sighted focus on stock price in order to maker sure it rises so that executives can cash out stock options and bonuses can be a very bad thing.

If, on the other hand, management genuinely believes its stock price is undervalued, then a stock buyback signals a good time to invest.

In other words, investors must carefully analyze both the quality of management and an assessment of their motivation to make a good investment decision. Only experienced investors willing to do in-depth research are going to benefit from this kind of investment analysis.

Higher dividends are a better way to judge how legitimate a banking stock move should be read. As investors have learned (and re-learned) time and time again, real cash payouts in the form of dividends are harder to fake with accounting tricks and bogus bookkeeping.

Investors looking to get back into the financial sector would do well to consider higher dividend payouts a better signal than big share buyback plan announcements. J.P. Morgan’s increasing its regular dividend by 20 cents and approving a large stock repurchase is better news than Wells Fargo’s announcement of a one time special dividend coupled with a large share buy back, for example.

Are you more inclined to buy bank stocks that are raising their dividends?

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