This past Tuesday, JPMorgan Chase (NYSE: JPM) CEO Jamie Dimon floated the idea of a special dividend while speaking at an investor conference. Business is good at the banking giant. Cash continues to accumulate, but it continues to accumulate at a rate that outpaces investment opportunities.
I give Dimon kudos for considering a JPMorgan special dividend for two reasons: It’s better to return excess cash to shareholders than to plow it back into investments that fail to generate a required rate of return. It’s important to remember that investments include your company’s stock. Dimon remembered.
Share buybacks have been the primary conduit through which JPMorgan returned excess cash to shareholders. Over the past four years, JPMorgan has bought back over 192 million shares. In June, it announced plans to spend $10.6 billion buying back shares through June 2017. Cash is also continually returned to shareholders through dividends.
The buyback conduit experienced a blockage recently – valuation. JPMorgan’s shares are up 29% year to date; they’re up nearly 22% since the election. JPMorgan’s shares trade at an all-time high of $85. Relative to book value, the shares are expensive. They trade at a 33% premium to book value and a 65% premium to tangible book value. (Tangible book value excludes intangible assets like goodwill.) In comparison, Citigroup (NYSE: C) trades at a 10% discount to book value; Goldman Sachs (NYSE: GS) trades at a more earth-bound 30% premium.
JPMorgan’s rich valuation renders share buybacks a less attractive use of excess cash. The bank is paying a significant premium to book value, which decreases the shares’ value proposition. Dimon recognizes this fact.
A special dividend is the better option, but JPMorgan needs to act fast if wants to maximize the option. The Federal Reserve is working on a proposal to limit the percentage of a bank’s capital that can be paid as a special dividend. If the new limit is adopted, all banks have until April 1 to act to maximize a special payment under the current rules. In JPMorgan’s case, it can pay up $1.8 billion as a special dividend if it acts now. The amount drops to just $450 million if it waits until April 1.
JPMorgan Special Dividend: A Good Deal?
What about investors? Should they act now to claim JPMorgan’s yet-to-be-determined special dividend?
JPMorgan’s maximum special dividend payment would parse out at roughly $0.50 a share. This would lift the trailing annual dividend yield to 2.9%. And if JPMorgan were to wait until the new Fed rules are implemented (if they’re implemented), then the yield based on a $0.125-per-share payment falls to 2.4%. Either special dividend would enhance the current dividend yield.
That said, we’re not looking at an exceptional pick-up in yield, but the JPMorgan special dividend still makes sense. Compared with its rivals, JPMorgan is rational for paying a special dividend, given that its shares trade at one of the highest multiples to book value in the sector. But compared with other income options from which investors can choose, JPMorgan’s special dividend appears less attractive.
Yes, the special dividend gooses the income proposition, but new investors will overpay for the proposition. If JPMorgan is less willing to buy back its shares at their current valuation, why should new investors buy an overvalued stock for a one-time special dividend on stock that management is more reluctant to buy?
A good idea, but a bad price. Though Jamie Dimon is right to prefer a special dividend over share buybacks, the income provided by the special dividend is insufficient to justify the lofty premium to book value investors would pay. In short, I’ll pass.