After years in the doghouse, Bank of America Corp (NYSE:BAC) has become a hot stock again. BAC stock doubled from its low last summer to its recent high at $25. It seems investors are finally starting to forgive the firm for its grave errors during the financial crisis.
Investors had almost certainly undervalued BAC stock previously. However, by the time it hit $25 this winter, one could argue that it was rapidly heading toward overvaluation. Is the recent 10% dip enough to justify new positions here, or is it better to let this correction play out first?
BAC Stock Cons
Trump Trade Over? The American banking sector has surged since Trump won. A rising tide lifted all boats, and BAC stock has enjoyed the ride. However, the wave may be crashing now. Trump’s domestic agenda has seemingly run aground as the Republican’s much-hyped health care initiative failed and uncertainty remains for the tax overhaul.
Instead, the White House’s attention has turned overseas. With dual active situations now in Syria and North Korea, the domestic agenda has taken the back burner. Investors had bought banks thinking that Trump’s stimulus policies would get the economy growing more quickly.
Interest Rates Falling Rapidly: Banks were supposed to make wider profit margins as the economy sped up. The Federal Reserve had suggested that there would be three rate hikes this year, and that, in theory, it would be a big boon for banks. Their net profit margins would soar as interest rates finally normalized, and banks would have much more cash flow with which to buy back stock or pay dividends.
The 10-year treasury bond, the key indicator for banking profitability, surged from 1.5% to as high as 2.65% over the last year. However, over the past month, rates have headed sharply in the wrong direction. Since the last Fed hike, the 10-year treasury yield has plunged to 2.25%. The decline in interest rates has accelerated over the past week, as geopolitical troubles pile up. In times of war, people buy bonds. And that’s the last thing BAC stock needs if it is going to keep rallying.
Not a Great Bank: Bank of America stock is cheap compared to peers, as I’ll discuss below. However there is a good reason for that. The bank performed terribly during the financial crisis, and recent operational performance (as opposed to the BAC stock price) has been just so-so.
The investment banking business has lost momentum compared to peers. And overall revenues in investment banking have been sluggish with soft markets for bond and stock underwriting in recent quarters. Bank of America has a huge deposit base, which gives it more interest rate leverage. That’s good when rates are rising, but poor in the last month’s environment. And others argue the bank’s cost-cutting efforts haven’t gone far enough. To put it briefly, while bulls correctly say the stock is cheap, it’s not entirely without justification.
BAC Stock Pros
Still Undervalued Versus Peers: Despite the huge run in BAC stock, it still looks cheap compared to other too-big-too-fail American banks. That’s because the whole sector has surged in unison; Bank of America stock hasn’t moved in a vacuum.
At this point, excluding one-off costs, BAC is trading at a 15x price-to-earnings ratio, compared to a 21x peer median across the industry. Perhaps more impressively, the bank is at 1.2x tangible book value, compared to 1.6x for U.S. banks as a whole and almost 2x for the largest capitalization ones in the United States.