Bank of America (BAC) is one of America’s largest and most well-known commercial banks. After a near-death experience during the financial crisis, BAC stock started to quickly recover.
But investors who bought the stock from 2013 onward have almost all lost money. Bank of America’s recovery has been slowed by several factors. Interest rates remain low, the credit markets have shown strain lately, and some investors still haven’t forgiven the company for the colossal mess made almost a decade ago. Is it time to put the past behind us and buy BAC stock?
Looks Cheap: BAC stock appears to be quite cheap. By several leading valuation metrics for banks, Bank of America is attractively priced. First and foremost, Bank of America is trading under tangible book value. For a bank that is significantly profitable, creditworthy, and located in a healthy economy, it is rather rare to trade under tangible value. That means that even stripping out intangible assets such as the brand name, Bank of America’s assets would be worth more liquidated than the market gives them credit for today.
The market is acting as though Bank of America’s assets are overvalued due to low interest rates. This is a valid concern, Bank of America is among the most levered of the big banks to interest rates. Still though, profitable banks trading under book value are worth considering closely.
BAC Stock Buyback: Bank of America had a $4 billion buyback in place last year. With BAC stock near the top end of the 52-week range, that amounted to 2% of the market cap. This wouldn’t make a huge dent in the outstanding amount of BAC stock, but every bit helps.
At the end of 2015, Bank of America had about $1.5 billion left on its authorized buyback. Now the company has gotten another $800 million added to the buyback suggesting the $1.5 billion remaining was already used; probably at better prices than were available in 2015. At present, the buyback continues at what appears to be an accelerating speed while the BAC stock price languishes far below its 52-week high at $18.48. This provides maximum value for shareholders.
Little Oil Exposure: High yield debt has been a troubled market lately. With the cataclysmic drop in the prices of oil and natural gas in recent years, many North American energy producers have filed bankruptcy or have a high potential of doing so in the near future.
Some US banks have a great deal of exposure to this risk. Regional banks such as Cullen/Frost (CFR) that focus on energy lending have seen their share prices pounded. And it’s not just the Texas banks that have exposure. Among the majors, Wells Fargo (WFC) has arguably the most exposure to oil, and its share price remains near 52-week lows even as the rest of the market rallies. Bank of America, on the other hand, has roughly just 3% of its loan book tied to oil, and this small figure will keep it insulated from any further fallout that may come from the sector.
BAC Stock: Cons
BAC Stock Is Very Volatile: Bank of America is among the most volatile of major American financial institutions. In fact, it often is more volatile than even the filmiest of the large European banking firms. BAC stock fell from $18 to $11 in about a month earlier this year. For a firm that, even after the plunge, has a $133 billion market cap, that’s incredible. Goldman Sachs (GS), itself no stranger to leverage and uncertainty, fell only about 20% during the span.
Some of this volatility is to be expected with a relatively low-quality bank with questionable management. Still, the size of the moves is jarring. Banking, more than most industries, relies on the market’s confidence. In 2008, as we saw, the moment firms lost the market’s confidence, they almost immediately were hit by runs on the bank and promptly failed or had to be rescued by the government. If BAC stock can get hit so hard in a relatively peaceful period such as early 2016, it’s fair to ask if the company will be able to survive during a serious finance-industry led bear market.
Low Yield: Bank of America shares offer a low dividend yield. It’s quite normal that financial industry companies offer yields in excess of 3%. BAC stock used to pay a high yield, but then the 2008 financial crisis hit. The company was forced to slash its dividend to just a token payout due to this.
The negative reputation that the bank developed during the financial crisis hasn’t gone away. For better or worse, the bank still is scarred by the negative events that happened years ago. This could be a source of upside, if the bank is re-rated as its negative past reputation starts to fade. But a big part of that is normalizing the dividend. At 20 cents a year, the dividend yield is just 1.4% and isn’t high enough to attract many investors.
Poor Earnings Outlook: At a 10x P/E ratio, BAC stock might look cheap by itself. But for big money center banks, low P/E ratios are the normal state of affairs. Especially for US banks, since they’ve lost their credibility as stable long-term investments. It’s hard to ask investors to pay much more than 12 or 13 times earnings for a money center bank nowadays. For comparison’s sake, JP Morgan (JPM) trades at just 10.4x earnings, has more credible management, and offers a much better 2.8% dividend yield.
On top of that, the earnings outlook for Bank of America is rather poor. The company is more tied than most to interest rates. Continued low interest rates will do BAC stock a great disservice. The Fed’s recent decision to greatly scale back the speed of the interest rate hikes will likely prevent the company’s interest ratio from expanding, and cap upside on earnings and the stock for the next few quarters.
BAC Stock: Verdict
Bank of America has done a decent job pulling out of its existential 2008-09 crisis. Many investors unfairly judge the company today for a past that’s rapidly receding into history.
That said, BAC stock is no screaming deal at this point. Yes, it’s very nicely priced in that it’s under tangible book value. But the lack of an especially low P/E Ratio, much earnings growth, or a respectable dividend will keep the stock’s upside firmly capped. From my perspective, BAC stock is decent for trading, since it is so volatile, but there are other banks I’d rather invest in.
At the time of this writing, Ian Bezek held no position in any stocks mentioned. You can reach him on Twitter at @irbezek.
