Should You Buy Bank of America Corp (BAC) Stock? 3 Pros, 3 Cons

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It’s no secret that financial stocks have led the way as part of the so-called Trump rally. The Financial Select Sector SPDR Fund (NYSEARCA:XLF) has rallied 30% over the last year. That’s certainly impressive. And Bank of America Corp (NYSE:BAC) has run even hotter. BAC stock has surged a jaw-dropping 67% over the last year.

Bank of America BAC stock

However, BAC stock peaked in March. Since then, it has largely traded sideways. The momentum traders who piled into the stock are starting to get bored, and some of the fundamentals that powered the rally in financials are now starting to fade. Despite that, will Bank of America stock resume its climb? Or is now the time to take some profits?

BAC Stock Cons

Interest Spreads Falling: The rally in financial stocks arose largely because investors expected that the Trump presidency would lead to reflation. That is to say, higher inflation and interest rates. At first, everything appeared to go properly on this front.

Over the past months, though, things have headed in the wrong direction. The Fed has raised rates, and talked of further hikes. This has driven up short-term interest rates. However, long-term interest rates have started to slump as observers lose faith in Trump’s promised political reforms. This has caused the spread between long-term interest rates and short-term rates to retreat back to pre-election levels.

Banks make money paying savers a low interest rate and then, hopefully, lending on a long-term basis – such as a mortgage – at a much higher rate. Now that banks are forced to pay depositors more due to rising short-term rates, but mortgage rates are sliding, bank profits are contracting. This is hardly the promising future that bank investors bought into last November.

Trading Slowdown: Bank of America isn’t just a major retail bank. It’s also is one of the nation’s leading investment banks. That’s not a good place to be in 2017. Goldman Sachs Group Inc (NYSE:GS) is the most notable example. The almost pure-play investment bank has seen weak results due to the persistent low volatility environment.

Unfortunately, that has hit BAC stock as well. Bank of America, in its most recent quarter, reported that global markets income dropped from $1.21 billion to just $928 million. Results suffered from declining volatility in both stocks and other instruments. Trading revenue dropped 9%, while FICC (fixed income, currencies, and commodities) income slumped 14%. Until volatility picks up, these segments are likely to continue putting up weak results.

Mediocre Performance: BAC stock looks cheap (see below). However, there’s a good reason for that. The company has earned lackluster returns on investor’s capital for the past decade. This most recent quarter bumped the company’s return on equity “ROE” up to 8%.

That’s it’s highest level in a decade, but it’s still far short of the 10% level that an above-average bank earns. This late into an economic recovery and this far into extensive turnaround and cost-cutting performance, investors have reason to ask for better. CEO Brian Moynihan has run the company for seven years now, and at some point investors will complain if BofA doesn’t improve its performance compared to its peers.

BAC Stock Pros

Other Banks Hit By Scandals: Following the financial crisis, Bank of America developed a rather unsavory reputation. Many people avoided the bank due to its perceived tendency to do wrong by its customers.

However, that perception has faded with time. Meanwhile, other rival banks have sullied their reputations with scandals. While Toronto-Dominion Bank (NYSE:TD) hails from Canada, it also has a large U.S.-based banking operation. Earlier this year, traders dumped TD stock following news that the company’s bankers were “forced to lie” to meet sales targets.

Meanwhile, formerly squeaky clean Wells Fargo & Co (NYSE:WFC) was hit with a huge customer-abuse scandal last year. And new reports surfaced Thursday claiming that Wells Fargo stuck unwitting car loan customers with unnecessary auto insurance. As rival banks face scandals, Bank of America looks better and better to prospective customers by comparison.

Still Relatively Cheap: Despite the huge run in BAC stock over the past year, it still seems pretty cheap. It currently trades for 14.5x trailing and 11x forward earnings. That seems like a steal compared to the stock market as a whole. Even factoring in that banks generally trade at a lower PE ratio than the S&P 500, the valuation gap is still large.

Additionally, BAC stock still trades at a slight discount to book value — it’s at 0.96x, to be precise. That means, that for every 96 cents you invest in BAC stock, you are getting a dollar’s worth of stated assets. Now, this discount was much larger last year. However, there are few large American banks trading under book value. And the global large bank sector trades at a median 1.2x book value, suggesting a near 25% discount for BAC stock on that measure.

Rebounding Dividend: Investors typically buy into bank stocks for their large and stable dividends. The financial crisis shook this paradigm to the core. Many leading US firms, including Bank of America, chopped their dividends to almost nothing. BAC stock paid a pitiful one cent a quarter dividend for quite awhile following the crisis.

However, Bank of America has turned the corner. They hiked the dividend to 5 centers per quarter in 2014. In 2016, they jacked it up another 50% to 7.5 cents quarterly. This next quarter, the bank is taking that dividend growth up in a big way.

The new payout will be 12 cents per quarter. That pushes the dividend yield up to 2.0%, a respectable figure. Additionally, there should be plenty of room for further hikes in coming years, as the bank’s payout ratio remains modest.

Verdict

I’m not a big fan of the large American banks. The government’s regulatory changes following the financial crisis probably aren’t adequate. A long-term bet on something like BAC stock requires more faith in Washington than I possess.

That said, BAC stock looks like a great trading vehicle. It’s still cheap compared to both its peers and the market as a whole. Depending on how interest rates go, the stock could pop nicely along with giving holders a rapidly improving dividend.

As of this writing, Ian Bezek did not hold a position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2017/07/should-you-buy-bank-of-america-corp-bac-stock-3-pros-3-cons/.

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