2020 Dividend Stock Portfolio

3 Best Dividend Stocks to Buy in August

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Three bank stocks for dividends and the best opportunity of 2020

Hey Bow Tie Nation, Joseph Hogue here with an update to our 2020 Dividend Stocks portfolio and three stocks I’m buying in August.

And Nation, I’m excited about buying these stocks because they’re in a part of the market that is possibly the best undiscovered opportunity right now.

If you’ve been following bank stocks, the second quarter was not good! I’ll show you just how bad but the Fed hit the entire sector with its stress test and changing the rules on what they can pay out in dividends. But there is a huge disconnect here between bank stocks and the rest of the markets, something I think could come through for an upside surprise as early as the fourth quarter and add to those dividend yields.

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Tracking our 2020 Dividend Stocks Portfolio

I’ll be putting these stocks in the portfolio on M1 Finance, and I love the platform for that automatic investment rebalancing function. I can just put in what percentage of my money I want in each stock or fund and the website is going to automatically invest any new money across the group.

M1 is totally free to use and offers some great savings rates and features. I’ll leave a link below so make sure you check it out.

Put your investments on auto-pilot and never pay a fee to buy or sell stocks with M1 Finance – learn more here.

I’m only going to recap the dividend portfolio this month because I want to get to those three dividend stocks to buy and the hidden opportunity in this part of the market. Here we are on M1 Finance and about a 5% return on the portfolio, which is about double the 2020 return on the S&P 500 so far this year.

2020 Dividend Stock Portfolio
2020 Dividend Stock Portfolio

We’ve had some great dividend stocks picks. This Vanguard Real Estate Fund, the VNQ, is one of my favorites, actually a holdover from last year’s portfolio so not all of that 54% is this year’s return.

We added shares of AIG a few months ago, already a 27% return and this is one of the five highest return favorites among Wall Street analysts, so I still like this one along with its solid 4.3% dividend.

We added more of this Global Medical REIT, ticker GMRE, last month to give us a little more exposure to healthcare and real estate, and its 6.9% yield.

These next three are all income funds we added for diversification, really a great way to get access to some other income producing assets outside of stocks.

But if we scroll down, it hasn’t all been rainbows and unicorns. We added Carnival in January…at about the worst possible time. Towards the end of last year, the world’s largest cruise operator was looking like a great deal but we know how that turned out. I like it as a hold here but we’re not adding to the position.

These others at the bottom are all from the January/February dividend picks so still hurting from the sell-off but I still like the companies.

So that’s where the portfolio stands heading into August and not too bad with a 5% return so far this year, but now I want to show you the dividend stocks we’ll be adding this month because I think this could be one of the biggest opportunities for dividends and returns over the next year. I’ll put this video in our 2020 Dividend Stocks playlist so you can check back on some of those prior videos to see which stocks we added each month.

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Why Bank Stocks are the Best Opportunity of the Year

Now if we look at profits for the last quarter, we know that financials were just god-awful. Shares of financials companies in the S&P 500 reported earnings 53% lower than they were last year.

In a chart from FactSet Earnings Insight showing the earnings reported for each sector and every sector got hit but a few really stand out as losers. From the right, we see energy companies reported an unbelievable 165% drop in profits…most earnings were deep in negative territory for energy companies. Industrials and consumer discretionary stocks, so those retailers, they both did abjectly horrible. And then we see the financials; so banks, insurance companies and others in the sector. In fact, the financials reported the fourth-largest decline of all 11 sectors in the economy and banks were even worse off reporting profits were 77% lower than last year’s quarter.

Bank Stocks 2020
Bank Stocks 2020

Stocks of financial companies are down 22% so far this year compared to a 2.5% gain in the S&P 500 and a 24% run in tech stocks!

But here’s where we get to the hidden opportunity in this sector, the disconnect that nobody is watching.

One thing that was really interesting is while financials reported one of the worst earnings declines, it was the third best of the 11 sectors in revenue. In a chart of revenue growth over the last quarter, and again it was pretty bad for everyone. The only two sectors to report that profits grew compared to last year were IT and healthcare and that was only growth of 3.7% and 2%, so nothing spectacular.

But if you look at the financials sector, even though companies in the sector reported profits that were nearly the worst in the market, revenue fell less than half a percent. Sales at financial companies was down just 0.4% from last year’s second quarter compared to the rest of the market that reported an average 10% drop in revenue for the period.

So revenue, that top-line sales number, was fine but something in between sales and earnings just fell off a cliff…and in fact we know it was the loan loss provisions.

Loan loss provisions are a safety net banks make when the economy looks weak. Basically the bank tries to estimate how bad the economy could get and how many of its loans could go into default. It then sets aside a certain amount of money as a cash cushion in case those loan defaults do start to increase.

The way it does this, the bank will take that money out of its earnings and put it into this separate account, this loan loss provision account. That’s what we saw in the first two quarters of the year for these bank stocks. They still did relatively well on the revenue side but they’re taking so much money to put into these safety net accounts, these loan loss provision accounts, that there’s just nothing left when you get down to earnings.

Of the four largest banks, Wells, Bank of America, Citigroup and JP Morgan, has exploded to $24.6 billion…up almost 400% from just $5.2 billion in the last quarter of 2019. Just these four banks are sitting on $24 billion in cash in that what-if account.

Are Bank Stocks a Good Investment
Are Bank Stocks a Good Investment?

In fact, among the 17 largest banks with more than $100 billion in assets, reserves represented 32% of the projected loan losses over the next two years. These banks have set aside enough to cover nearly a third of all loan losses over the next two years and that’s the worst case scenario for defaults, the ‘severely adverse’ scenario in the most recent Fed stress-test of banks.

So there is a huge disconnect in the market right now. Everything else is priced as if the economy is going to bounce back. Analysts expect the economy to come rushing back next year for a 29% increase in earnings at S&P 500 companies while the financials are expected to do even better, reporting a 32% increase in earnings. In fact, we see here in the earnings estimates for next year, only companies in the consumer discretionary and industrials sectors are expected to post stronger profit growth.

If we look at the estimate for the entire market, here in a chart of annual earnings for companies in the S&P 500 from 2010 through 2021, analysts expect this year’s earnings to be rough with a 21% drop in profits. But the stock market is forward looking and the fact that Wall Street sees profits bouncing back to $164, just above where it was last year, that’s why stocks are doing so well.

Again, the overall market is up 2.5% from the beginning of the year but if you look at bank stocks, they’re down 22%…bank stocks are still trading like the sky is falling.

And they can’t both be right.

If the economy doesn’t fall apart, if we get anywhere near those earnings estimates for the S&P 500 next year, then banks aren’t going to see the wave of defaults they’re predicting. That means the tens of billions sitting in those cushion accounts, the loan loss provisions, are just sitting there and aren’t needed.

So do you start to see what I’m getting at? Just like taking that money out to put in the loan loss provisions caused bank earnings to be abjectly horrible, when they realize those loans aren’t going to default and they move that money back into the income statement…earnings are going to surge higher and surprise the market.

And with as much money as the government and the Federal Reserve is pumping into the economy, it’s hard to see how we get anything more than a mild recession. Between the Fed and fiscal stimulus, we’ve already seen $10 trillion pumped into the economy and probably more coming. Interest rates are so low that companies can basically borrow for free so I just don’t see how we get to that wave of loan defaults the banks are saving against.

Even if we do see an uptick in loan losses though, these bank stocks we’ll look at are some of the best value plays in the market and produce solid dividends to wait for that return.

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Three Dividend Stocks I'm Buying in August

So for our three dividend stocks to buy this month, I’ve put together three with some of the lowest price-to-book values in bank stocks. Banks with loan loss provisions that could reverse for huge profits and a surprise upside.

We’ll start off with the best value in bank stocks, Cititzens Financial, ticker CFG, and a 6.4% dividend yield.

Citizens is a smaller regional bank operating mostly in the New England states, mid-Atlantic and mid-West. The virus hit the North East hard but has really come under control there and the mid-West has done fairly well also. That leads me to believe the economic hit won’t be as bad here and the bank should do really well.

Against that optimistic outlook, Citizens has doubled it’s loan loss provision to $2.4 billion over the last two quarters. We’ll look at the balance sheet for each of our bank stocks and you can find how much they’ve put into those loan loss allowances down here in assets. See here that Citizens has increased that cash cushion from about $1.2 billion last year to over $2.4 billion in the most recent quarter. That $1.2 billion taken out of earnings has meant a scary plunge there to just three cents in the first quarter and $0.53 per share last quarter. The company is expected to grow earnings by 51% next year to $2.55 per share but there’s a very good chance it could do even better than that.

Shares of Citizens Financial are trading for just 0.52-times the book value of assets and the stock has a history of trading around 0.8-times book value, so we’re potentially looking at a 35% discount on the share price along with that dividend.

Analysts have price targets on the shares from $25 each at the low end, right around where the stock is trading now, to as high as $34 per share over the next year.

New York Community Bancorp, ticker NYCB, is an even smaller bank but still sports a 6.6% dividend yield and some safety to the theme.

Again, since the region worked through the virus fairly quickly, we didn’t see the numbers come down as hard on NYCB. Shares are down only about 15% from the beginning of the year and earnings didn’t take much of a hit at all. In fact, New York Community was one of the very few banks to report an increase in profits in the second quarter.

As a result, the bank hasn’t shifted as much into its loan loss allowances here, increasing it to $162 million from last year’s $149 million but that’s still $13 million dollars of earnings that could come back to shareholders over the next year or two.

Shares trade for 0.81-times book value, about a 15% discount to their longer-term average, and the dividend yield here is rock-solid. Since earnings haven’t come down, there’s no danger of that dividend cut like we’ve seen in other bank stocks.

Analysts are also bullish on the shares with a low target around $10.50 per share and a high around $14 each over the next year.

We’ve talked about Wells Fargo, ticker WFC, on the channel and I’m finally putting it in our dividend portfolio.

Now a 1.7% dividend yield wouldn’t normally qualify as a dividend stock in my book but this one just got cut and I think the worst is over for investors. The bank has put nearly $10 billion into its loan loss provision above what it normally holds and had to cut that dividend to protect cash flow.

But I don’t think it’s going to be long before Wells pushes that dividend back up and this is one of the best values in banking. Shares are down 55% from the beginning of the year and trade for a price-to-book value of just 0.63-times. And while I’d say a price-to-book of 1.0 is a pretty good target for most bank stocks, Wells Fargo has historically traded above that, around 1.2-times book value…so we’re talking potentially double that share price if the stock gets back to trading normally.

Earnings have been nasty over the last few quarters as the bank pushes more money into those loan loss provisions but profits are expected to rebound to $2.10 per share next year. That would still be about half of what they were last year but a huge improvement.

Wells is the leader in U.S. mortgages and that side of the market really hasn’t been hit as hard. I don’t see them needing nearly $20 billion in loan loss reserves and I think the stock price takes a big jump early next year when the dividend is reinstated. There’s a wider range of estimates than we saw in the other two stocks. Analysts have targets from just $21 at the low end to as high as $40 per share over the next year.

What I’m looking at is when that dividend does get increased, eventually back up to $2.04 per share where it was before the cut, that’s a dividend yield of over 8% for investors that buy at this price.

I love the auto-invest feature on M1, set the platform up to automatically reinvest your dividends and any available cash. Makes investing as stress-free as possible!

Put your investments on auto-pilot and never pay a fee to buy or sell stocks with M1 Finance – learn more here.

These dividend stocks will not only put cash in your pocket but all have great upside price potential. I'm adding them to our 2020 dividend stock portfolio on M1 Finance and will update you next month.

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