Bank of America Corp (NYSE:BAC) is one of the largest financial stocks in the world. BAC stock boasts a market cap of over $135 billion and annual revenue of more than $95 billion.
However, size isn’t everything. Bank of America stock has lost nearly 30% since early December, and its short-term chart has little to like. Longer-term performance is pretty ugly too, with shares up just 7% since the start of 2013 while the S&P 500 is up almost 35% in the same period.
So what gives? Why has this mega-bank been in such a tailspin, and what does the future hold for BAC?
The Federal Reserve is obviously a big part of things since interest rates are important to all financial stocks. But there’s much more going on here than rates alone, and investors need to get the whole story before thinking about buying or selling Bank of America stock here.
BofA Waiting on Rates News
We’ll start with the rates element because it’s the simplest to understand. In a nutshell, higher rates mean Bank of America can lend at better margins to businesses and consumers. But while financial stocks had some hope after the Federal Reserve inched rates 25 basis points higher in December, now there is talk of rolling back that increase.
Worse, there’s even talk of negative interest rates now that Japan and Europe have both seen their benchmark interest rates move below zero thanks to recent central bank actions.
The idea of negative interest rates is a head-scratcher on the surface, but it’s not very difficult to understand. U.S. banks deposit billions in the Federal Reserve system and earn interest on those deposits presently — albeit a very meager amount. But under negative rates, banks would actually be charged by the Fed for their deposits.
Since regulators demand a certain minimum level be kept at the Fed, there’s no risk of the money running out. But banks will certainly think twice before parking excess reserves at the central bank and will be more likely to lend instead.
This is a huge deal for Bank of America and other major financial stocks including Wells Fargo & Co (NYSE:WFC) and JPMorgan Chase & Co. (NYSE:JPM). Consider that a 0.25% return on $100 billion in reserves is $250 million in interest income to prop up operations … while a -0.25% rate means coming up with $250 million in payments to the Fed. That is a material swing, and at a time when cost-cutting and margins are increasingly in focus for big banks.
The next Federal Reserve meeting is March 15 and 16, so investors will be closely watching what happens there for a sign of what’s next for BofA and the other major financial stocks.
The Good News: BAC Stock Metrics are Sound
While the Fed pressures are a big “what if,” it appears that the market has priced in a heck of a lot of negativity for Bank of America stock. Consider that the stock currently trades at roughly half its book value!
Yes, earnings still remain under pressure … but that kind of pricing means that poor profit performance is baked in. Take a look at some of these key metrics:
| Stock | Return on Assets | Price/Book | Forward P/E |
| BAC | 0.75% | 0.5 | 7.3 |
| JPM | 1.00% | 0.95 | 8.7 |
| WFC | 1.35% | 1.4 | 10.4 |
Sure, JPM stock and WFC stock are looking better when it comes to return on assets — a key measure of efficiency at a bank. But valuation metrics including price/book and price/earnings reflect this shortfall in a dramatic way.
Bank stocks are cyclical, and the economy is certainly doing much better than it was during the financial crisis. However, these bargain metrics show that investors are still very much in doubt of whether Bank of America can hack it.
Anyone under the illusion that Bank of America is bound to fail simply isn’t paying attention. Not only would that be a tremendous blow to the broader economy and financial confidence, it ignores the tighter capital controls in place under Dodd-Frank and the huge strides that BofA has made to cut costs and deleverage its operations to reduce risk.
So why is BAC stock priced at crisis-era levels still?
Part of the problem is the meager 5-cent dividend that equates to 1.6% in yield — less than 10-year Treasuries, and half that of peers JPM and WFC. Another part of the problem is a top line that’s going nowhere. When your ROA lags that of your peers and you’re losing business slowly, it’s a recipe for declines.
However, the dividend is incredibly sustainable and overdue for a significant bump. After all, 20 cents annually is less than 13% of projected FY2016 earnings. And while the top line is challenged, the story is the same for both Wells and JPM, so that’s not a reason to buy them over Bank of America.
If anything, the aggressive cost cutting and bargain pricing makes BofA more attractive than its peers.
There’s risk here, of course, particularly if rates are cut to zero or lower and if the economy slows significantly. But that holds true for all cyclical stocks.
If you’re confident in the U.S. economy and looking for value, BAC may not be a bad bet.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the aforementioned securities.
