It's widely documented that over time, stock dividends provide a significant portion of the overall return on investment. Yet, the value creation assumes several implications. First, the shares are held long enough for the dividend to create meaningful value. Second, the dividend can be counted on for the foreseeable future.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

What Matters Most
Even if dividends create tremendous value over the long run, that reality means nothing to an investor if the underlying stock starts to decline significantly. Although a stock decline implies a higher dividend yield, in most cases such as an abnormally high yield, it will not last for long. Remember the dry bulk shipping industry? So, it's silly to chase dividends that are coming from unreliable companies. Instead, if one can find a company with strong prospects of maintaining and even increasing the dividend payout over time, there is a good chance that the company's stock price will also do well for investors over time. Believe it or not, today's banks may offer that opportunity of solid dividend payouts and growth potential.

Starting all over
Before the financial crisis hit in 2008, many of the largest financial institutions were considered consistent dividend payers, thanks to solid growth prospects. That idea came to a screeching halt when the credit markets froze and housing collapsed. Virtually all of the banks eliminated dividends as a way to preserve capital. As a result, those banks lost a wide base of investors who were rightfully concerned about the future solvency of the banks.

Fast forward to today and the picture is changing. Banks are cleaning up their balance sheets and capital ratios are vastly improved. Dividends have come back to some, while others are likely to reinstate the dividend as soon as regulations allow. In addition, bank shares remain at attractive valuations after a 50% drop in 2011. While 2012 has been a great rally so far for banks, the share prices in some cases do not fully reflect the tremendous progress. Going forward, banks have the opportunity to provide solid yields and stock price appreciation.

JP Morgan (NYSE:JPM) and Wells Fargo (NYSE:WFC) are good examples. After the recent round of stress tests, JPM announced another dividend increase along with a stock buybacks. Shares now trade for $45 and yield 2.7%. Last year, shares traded as low as $27.85 and buyers at that price are now picking up close to a 5% yield. Going forward, JPM will likely increase its yield again. Wells Fargo also yields 2.6% and Warren Buffett continues to buy the shares. When feasible, Wells Fargo will likely boost its dividend payout. For related reading, see The Kingpin Of Wall Street: J.P. Morgan.

One name ready to boost its dividend is Citigroup (NYSE:C). Citi currently pays out 4 cents and a negligible yield of 0.1% at today's share price of $37.70. But management realizes that its shareholders deserve a higher dividend, and as the company continues to improve its capital ratio, a dividend increase is expected. With shares trading at about 60% of book value, there is plenty of room for long-term share price appreciation. AIG (NYSE:AIG) is another large financial name that will one day start paying dividends. Shares trade at 50% of book and 10 times forward earnings.

In short, banks are starting all over again. They eliminated the dividends to shore up balance sheets and conserve capital. Going forward, bank executives are likely going to maintain a very cautious approach as to not risk a repeat of 2008. One of the best ways to illustrate that is by paying out dividends.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  2. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  5. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  6. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  7. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  8. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  9. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
  10. Stock Analysis

    The Safest Stocks You Can Invest in Right Now

    These stocks are likely to hold up better than others in a bear market, but there's a twist.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!