The Federal Reserve announced last week that the 23 large U.S. banks that took its most recent stress tests passed with flying colors, meaning they had enough capital and liquidity to continue lending in a severe economic downturn (you know, like the one we had last year).
The Fed said that the largest U.S, banks are in good shape and are “strongly positioned to support the ongoing recovery,” according to the Fed’s vice chair for supervision, Randal Quarles.
This week, most of the large banks responded to the Fed report by announcing dividend increases and share buybacks for the third quarter, as many had been forced to curtail any increases or share repurchase programs due to the pandemic. The bank that made the biggest splash is Morgan Stanley (NYSE:MS), which announced on June 28 that it is doubling its quarterly dividend.
That type of increase should surely get investors’ attention. But is Morgan Stanley the dividend stock for you?
Morgan Stanley is firing on all cylinders
Morgan Stanley doesn’t need much of an introduction to most investors. It’s one of the largest investment banks in the world and among the leading asset managers and wealth management firms. The company had record revenue in 2020, driven by its investment banking and institutional trading businesses. It also made two huge acquisitions, Eaton Vance and E*Trade, to bolster its investment management and wealth management businesses, respectively.
It also had a strong first quarter, posting record revenue and net income. Revenue climbed 60% year over year to $15.7 billion while net income more than doubled to $4.1 billion, driven by continued strength in investment banking and trading, as well as growth in investment management and wealth management due to the integration of the acquisitions.
It raised its return on average tangible common equity, which is a measure of a company’s physical capital, to 21.1%, up from 9.7%. Also, its common equity tier 1 ratio, which gauges the company’s solvency and ability to withstand an economic shock or loss, is 16.7%, which is well above the regulatory minimum of 4.5%. This growth and expansion has lifted the stock price 32% year to date.
A 100% dividend increase
As a result of its earnings power and capital strength, Morgan Stanley will double its quarterly dividend in the third quarter from its current $0.35 per share to $0.70. That calculates to $2.80 per share annually, up from $1.40.
CEO James Gorman issued a statement saying:
Morgan Stanley has accumulated significant excess capital over the past several years and now has one of the largest capital buffers in the industry. The action taken by the board reflects a decision to reset our capital base consistent with the needs we have for our transformed business model. In particular, Wealth Management and Investment Management provide stable and durable earnings that support a significantly higher payout ratio. Going forward we remain amply capitalized to drive further growth.
The change marks the first dividend increase for Morgan Stanley since the third quarter of 2019 when it went from $0.30 per share to $0.35. Currently, it has a 1.5% yield, which is about the average on the S&P 500 but is low for the financial sector. The yield has remained in that range steadily over the past five years. The payout ratio is very low at 20%, which is as low as it’s been in the past five years.
While the 100% increase might seem high, it looks to be sustainable given its low payout ratio and its strong financials and earnings. With the new dividend factored in, the yield right now would double to about 3%, if you divide the stock price by the annual per share payout. The payout ratio would go up to about 40%, based on a $2.80 per share annual dividend and an estimated 2021 earnings per share of $7. That’s still a very manageable payout ratio, given Morgan Stanley’s leadership position and earnings outlook.
So, Morgan Stanley went from a pretty average dividend stock to an excellent dividend stock with this increase. But it’s not only a great dividend stock, it’s also a good buy overall that should deliver both income and capital appreciation for years to come.
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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