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Banco Santander SA Could Be Worth 970p

Banco Santander (LSE: BNC) (NYSE: SAN.US) is a queer fish among the banks.

Whereas most focus on paying sustainable dividends that are well covered by earnings, Santander has been providing shareholders with what, on the face of it, look like ridiculously high yields.

Take the year ended December 2013, for example, when Santander paid out 60 eurocents per share for a  stunning yield of 9%! That was nowhere near covered by earnings per share (EPS) of 40c.

A bank on a P/E of 26!

SantanderBut it was considerably more conservative than the previous year, which saw a 59.6c dividend yielding 9.9%. That was more than two and a half times EPS of 23c — and the year ended with the shares on a P/E valuation of 26!

How did it do it? Well, the trick is that a very large number of Santander shareholders have traditionally taken their dividends as a scrip option, so most of the cash actually doesn’t have to be shelled out — the bank just issues new shares.

Now, there’s nothing for free in this world, and issuing large amounts of new shares each year inevitably results in a weakening share price as each year’s profits are spread thinner and thinner.

Santander shares might be up 35% over the past 12 months, but they’re down around 40% since their 2010 peak and today stand at 630p.

Set to change

It’s just not a sustainable strategy, and analysts are expecting Santander’s dividend policy to become more conventional in the coming few years. If forecasts are anything to go by, we’re likely to see the dividend slashed to a manageable 32c per share by 2017.

So, what share price might be realistic by December that year?

There’s a tentative prediction of 73c per share out there, and assuming a P/E close to the long-term FTSE average of around 14, that would suggest a share price of about 825p.

Dividends, though set to decline, will still be significant, and we could see an extra 180c or so (about 145p), to take the total share valuation to 970p.

Against a share bought today, that would be a 54% gain.

Worth buying?

Is Santander worth investing in today? I can’t help feeling the bank’s unusual dividend policy has led to inefficiencies in share price evaluation. But whether a true valuation has been overblown by the seductive headline yield or given the thumbs-down by those who know it can’t last — well, that’s for you to decide.

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Alan does not own any shares in Banco Santander.