Payout ratios indicate direct return to investors
Investors can’t have share price appreciation unless they sell the shares. Payout is the direct return to investors.
Many investors, especially pension funds and IRAs (individual retirement accounts), often seek higher payouts for their unique needs. These investors require regular payout to fund their incomes. Companies with higher payouts often trade at premium valuations.
Wells Fargo’s payout ratios improved in 2014
Wells Fargo’s (WFC) payout ratios improved in 2014. Dividend payout ratio rose 34% in 4Q14 compared to 29% in 4Q13. This was possible due to the bank’s strong capital position.
This meant that Wells Fargo had to hold on to the lesser amount of profits for capital purposes. The net payout thus improved to an excellent level of 72%. This was a significant improvement from net payout of 43% in 4Q13.
Return on equity: An important parameter for shareholders
Return on equity is the amount of percentage of return a shareholder receives. All else remaining constant, it’s better for a bank to have a high return on equity. However, a bank may also increase its return on equity by taking higher risks such as disbursing high-risk loans. Banks with a combination high return on equity and a low bank efficiency ratio are the best.
Return on equity dropped in 2014
Wells Fargo’s return on equity was 12.45% at the end of 4Q14. This was a drop of 13.31% at the end of 4Q13, in spite of a fall in the total number of common shares outstanding. The net drop in outstanding common share was 45 million in 4Q14.
Wells Fargo’s (WFC) fall in return on equity was largely a sector-wide phenomenon. Major banks such as JPMorgan (JPM), Bank of America (BAC), and Citibank (C) reported a falling trend in return on equity. All these banks are important in the Financial Select Sector SPDR (XLF).