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The Fed stress tests are done, and with it brings a new breed of dividend leaders.
Many of the major banks and financial institutions got the OK from the Federal Reserve to start returning more cash to shareholders last week.
With this, financials will overtake the information technology sector as the dividend leaders of the S&P 500.
Financials are now paying over 15.1% of the S&P 500’s total dividends, versus just 14.6% prior to the stress test results. Meanwhile, the IT sector makes up 14.8% of S&P 500 dividends.
Bank of America (NYSE: BAC) was the big focus of this year’s Federal Reserve stress tests and barely squeaked by with provisional approval.
Citigroup (NYSE: C) had a big surprise for investors when it passed its stress test with flying colors.
However, there were some underrated winners of the stress tests. Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS) are a couple that will be boosting dividends.
Goldman can up its dividend by 13% to $2.60 a share, which is a pro forma yield of nearly 1.4%. And Morgan Stanley can up its dividend by 50% to 60 cents a share, putting its pro forma yield at 1.65%.
However, it’s worth noting that both Goldman Sachs and Morgan Stanley had to resubmit their capital plans to the Fed before getting final approval.
And among the underrated financials boosting its dividend is Warren Buffett favorite American Express (NYSE: AXP). It got the go-ahead to up its dividend from the current $1.01 annual payout to $1.15, which puts its pro forma dividend yield at over 1.4%.
In his annual letter, Buffett again touted the benefits of owning a small piece of great businesses, rather than the entirety of average companies. He was specifically talking about his top four positions – one of which is American Express.
However, AmEx shares are already down 13% year-to-date. This is mainly due to some negative press related to Costco’s (NASDAQ: COST) announcement that it will no longer exclusively accept AmEx credit cards at its stores. Even still, for long-term investors, could this be a great buying opportunity for a great company?
Shares of American Express are now trading at a price-to-earnings ratio of 14.5. Its five-year average P/E ratio is 16, and other players in the credit services space are trading at much higher valuations. Consider Visa (NYSE: V) and MasterCard (NYSE: MA), both of which trade at P/E ratios of nearly 30.
Despite the news that Costco stores will stop exclusively accepting American Express in U.S. stores, AmEx is still one of the prime players in the credit card space. It has an affluent cardholder base and should continue to benefit from more credit-related spending as the economy strengthens.
One of the big advantages that American Express has over the likes of Visa or MasterCard is that it both issues cards and manages transactions with merchants. This means that AmEx has a large network of transactional data that it is working on monetizing.
American Express is also expanding its market by tapping into low-risk markets, like prepaid cards, which should expand its network base and its transaction data.
In the end, the financial sector’s dividends are still well below where they were in 2007. The financial sector dividends account for 15% of the S&P 500, compared to 30% eight years ago.
And all financial stocks are not created equal. The key is to be selective. American Express still has a strong brand and it’s a Buffett favorite.
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