It has been two weeks since Bank of America Corp (NYSE:BAC) reported its fourth-quarter earnings. Generally well received, BAC stock is up 1.9% between its Jan. 12 and Jan. 27 closing prices, an annualized return of almost 50%.
Bank of America rebounded nicely in 2016; InvestorPlace feature writer James Brumley reminded investors the day before earnings suggesting that on balance, BofA’s positives outweigh its negatives.
Especially when you consider that a 100-basis-point increase in both short-term and long-term interest rates could add $7.5 billion in net interest income over the next 12 months.
That’s a boatload of money and a big reason why many in the investment media believe BAC stock is still cheap relative to its peers. InvestorPlace contributor Chris Martin recently pointed out that Bank of America stock is still 50% below where it traded a decade ago trading at just 15 times its 2016 earnings-per-share.
I, myself, labeled BAC stock a steal last April, citing Warren Buffett’s love of the stock, its valuation and its share repurchase program. Since April 6, 2016, when my article appeared, BofA stock is up 72%.
While Martin views BAC stock to still be cheap, I’m not certain that the next 72% gain will come nearly as easily.
Here’s why.
Three Reasons to Put the Breaks on BAC Stock
Return on Tangible Equity: Brumley’s article, written before Q4 2016 earnings, suggested that investors keep an eye on BofA’s return on tangible common equity, which hit 10.3% in the previous quarter, an indication that the bank is getting its act together.
Well, it came in at 9.92%, well above its Q4 2015 return of 7.19%, but 38 basis points below the third quarter, a sign that barring significantly higher interest rates or move-the-needle expense cuts, its return has probably hit a wall for the time being.
Bank betas: In mid-December, I wrote about the rising risk of bank stocks given their betas relative to the market, which at the time sat around 1.4, or 40% more volatile than the general market. At the time, BAC had a beta of 1.61; a month later it’s around 1.5, suggesting BofA and bank stocks generally have gotten marginally less susceptible to a correction.
Although it’s hard to know how the current issues surrounding the Trump administration will negatively affect bank stocks, the next few years could be a boon for U.S. banks, as regulations are loosened providing lots of ammunition for anyone long on BAC.
“The financial system is going to be at least partially deregulated,” Steven Eisman (the guy played by Steve Carrell in “The Big Short”) told CNBC in December. “I think over the next couple of years there is going to be more leverage. And this will be a golden age of investing in financial stocks.”
So, at least from this perspective, a high beta relative to the market might not matter if Eisman’s prediction comes true.
Alternatives: While it’s true that both Goldman Sachs Group Inc (NYSE:GS) and Wells Fargo & Co (NYSE:WFC) have BAC stock on their list of top stocks to buy at the moment, I would be remiss when talking about any bank if I didn’t offer up possible alternatives, especially when you consider how much of a run Bank of America stock hass been on in the last year.
Although I’m not a huge fan of Jamie Dimon’s, JPMorgan Chase & Co. (NYSE:JPM) is a better bank than BAC and its Q4 2016 return on tangible equity — 14.0% for JPM versus 9.9% for BofA –suggests investors at least ought to consider its stock given that its current yield of 2.2% is 89 basis points greater than Bank of America and its P/E of 15 is 160 basis points less.
Bottom line on BofA
If you believe Bank of America is the cheapest big bank stock to own, you should buy it because it will benefit from rising interest rates. That said, a rising tide lifts all boats, so a better play might be to buy a bank-focused exchange-traded fund with BAC stock as one of its top five holdings.
However, I don’t see any red flags beyond the fact it needs to bring its return on tangible equity within throwing distance of JPM. This past quarter failed to make a dent and that should be disappointing to current BofA stock owners.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
