Bank of America Corp (BAC) had a middling finish on Wednesday after its third-quarter report, despite a pretty robust start to the day.
That initial spark came on good news on the earnings front — Bank of America is performing very well right now.
However, while BofA is looking good on a performance front, and while BAC stock looks very cheap right now, whether Bank of America shares are a good investment right now actually comes down to things outside of BAC’s control.
Bank of America Earnings Show Major Improvement
Bank of America earnings came to 37 cents per share in the third quarter. This represents a massive reversal from last year’s loss, which came during a period in which BAC had to pay billions in a settlement with the U.S. government over mortgages.
On the flip side, revenue fell 2.4% year-over-year to $20.91 billion.
Nevertheless, BAC’s results were still better than expectations of $20.77 billion in revenue and an earnings of 33 cents per share.
Bank of America is performing very well in a tough environment for banking, thriving in areas of its business that it can control. For example, non-interest income increased 1.6% in the quarter to $11.2 billion. This is revenue created from trading equities and bonds, along with mortgage banking.
And What About BAC Stock?
As long as Bank of America is performing (and it is), BAC stock looks like an obvious buy at current prices well below book (0.7).
If we exclude legacy assets, BAC’s loans and leases rose by $19 billion from the second quarter to $729 billion. Further, client brokerage assets rose 8% to more than $117 billion.
However, despite these noted improvements, BAC’s total revenue still declined 2.4%. The reason was a 7% decline in net interest income to $9.7 billion, and the underlying reason for this decline is low interest rates.
In fact, low interest rates bring up the big unknown surrounding BAC stock, and all large financial institutions for that matter:
When will interest rates rise?
The Federal Reserve has long seemed to point for an interest rate hike from historic lows sometime this year, but with just a couple months left in this year, the Fed is running out of time. The Fed’s decision on interest rates is supposed to be independent of the stock market, and politics. Instead, the Fed looks at the strength of the U.S. economy, which for banks might not be a good thing.
On the same day that BAC announced earnings, JPMorgan cut its GDP growth outlook for the U.S. from 1.5% to 1%. And before that, Goldman Sachs lowered its outlook from 1.5% to 1.2%.
Therefore, if the Fed didn’t think the economy was strong enough last month for a rate hike, why would now?
All things considered, banks benefit from higher interest rates, with a 100-basis-point rise in interest rates able to create BAC an extra $4.5 billion in net interest income, according to Bank of America. Theoretically, the company would then return to overall revenue growth with higher interest rates. But if the Fed misses its 2015 goal, and low interest rates carry well into 2016, there’s a good chance that BAC stock will continue to trade where it is now.
As a result, it might be wise to wait until the Fed actually hikes interest rates before buying BAC stock. The reason is because BAC’s 1.3% dividend yield is not a big enough safety cushion while waiting for interest rates to rise. Once that hike occurs, BAC stock should surge as its net interest income rises and its non-interest income remains strong.
At that point, BAC is a growing company that’s trading well below its book value per share — and in a market that has risen 70% over the last five years, that kind of value is hard to find.
As of this writing, Brian Nichols did not hold a position in any of the aforementioned securities.
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