With litigation behind it and an improving economy set to boost its profits, this mega-bank looks attractively discounted.
Bank of America (BAC)
from Ian Wyatt’s Million Dollar Portfolio
Bank of America (BAC) is the second-largest U.S. Bank. With total assets of nearly $2.2 trillion, the bank trails only JP Morgan (JPM).
BofA has retail and commercial banking operations and 5,000 offices throughout much of the U.S. It is also the largest issuer of credit cards, through its acquisition of MBNA. And its 2008 acquisition of Merrill Lunch helped transform the bank into a leading securities firm.
There are four primary reasons to buy Bank of America today.
In the wake of the financial crisis, BofA has paid out an astounding $65 billion in fines, financial restitution, and legal fees—the latest, a $17 billion settlement with the Department of Justice related to its mortgage lending practices.
Those financial settlements have clouded the real financial performance of the business. Because the bank needs to write off these legal expenses, the real profits of the business have been depressed.
In the third quarter of 2014, BofA reported net income of $168 million—a tiny profit for a company with quarterly revenues of more than $21 billion. The DoJ settlement was more than expected, and resulted in an additional $5.6 billion litigation expense ($0.53 per share) in the quarter. Without these expenses, the bank would have turned a very healthy profit. The good news is that BofA says that it has resolved 95% of the claims related to mortgage securities.
Next, for banks, low interest rates aren’t a good thing. Banks earn less on their deposits. Net interest margins—the difference between what a bank earns on loans, compared with the amount it pays depositors—have been historically low, due to the Fed’s easy-money policy.
With interest rates at 0%, they can only go up. For every 1% increase in interest rates, BofA pre-tax profits grow $3 billion per year, adding about $0.19 to the company’s EPS.
In late 2006, BofA stock traded as high as $55. At the current price, the stock remains 68% below its all-time high. Next year, Wall Street analysts expect the bank to turn a profit of $1.48 per share on revenues of $89 billion. That means that the stock trades at a forward P/E ratio of 12, pretty cheap compared with the forward P/E of 17 for the S&P 500.
With banks, , stock prices are more closely correlated with book value, since much of a bank’s value is connected with the values of loans or investments that the bank has made (rather than products that are being developed). Wells Fargo trades at 1.7x 2014 book value. Meanwhile, BofA trades at 0.8x book value—a 50% discount.
In 2008, BofA’s quarterly dividend reached $0.64 and by 2009, had been cut to a tiny $0.01 per share. In September of this year, it was finally increased—to $0.05 per share, about a 1.2% dividend yield. Even though the dividend grew 500% in the last few months, that small yield isn’t attracting income investors to BofA stock.
Analysts predict that by 2017, the annual dividend will be $0.55. Investors who buy BofA stock at current prices could have a cost-basis dividend yield of 3.1% in just a few years. And companies that consistently raise their dividend payments tend to outperform.
Two or three years from now, the last financial crisis will be even further in the past. As a result, big banks should trade in-line with the market as a whole. I believe Bank of America stock will deserve a more normal and market-correct P/E multiple of 15. The stock could be worth $30 within the next three years—a 71% premium from recent prices. Buy below $19.
Ian Wyatt, Ian Wyatt’s Million Dollar Portfolio, www.100kportfolio.com, 802-434-6900, December 10, 2014