Bank of America Corp: A Cheap Stock That Could Double Your Investment (BAC)

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The stock market had struggled for most of 2016, but is finally finding its footing. The real head-scratcher here is why some of the largest banks in the country are still down by double-digit percentages this year.

Bank of America Corp: A Cheap Stock That Could Double Your Investment (BAC)

Bank of America Corp (BAC), by many measures the largest bank in the country, has logged a negative return of over 17% so far this year.

This makes it one of the worst-performing large banks, which is surprising for a number of important reasons.

BofA concedes it is operating in a difficult environment, but the low growth and low interest rate environment it finds itself in will eventually end.

Growth prospects are already improving, and although rates are ticking up slowly they could start to increase steadily as soon as the end of the year.

A Huge Potential BAC Catalyst: Rising Rates

The inevitable rise in interest rates in the U.S. has been one of the most widely anticipated events in banking, yet has failed to come to fruition for the better part of five years now. Historically low rates are a consequence of the Credit Crisis and a Federal Reserve that is doing its best to engineer a sustainable economic recovery.

In its most recent decision on April 27, the Fed decided to hold the federal funds rate steady at 0.25% to 0.50%. It sees respectable job growth, but noted that the economy is on tepid ground where “activity appears to have slowed.” Inflation is also below its 2% goal, all of which mean it will stay steady on rates until job growth and inflation increase for now.

Yet, rates have increased slightly since last year, and are expected to take another turn upward by the end of the year — potentially sooner if job growth continues. The eventual increase is a big potential catalyst for BAC stock. It estimates that a 1% increase in interest rates would result in a $6 billion increase in its net interest margin.

This could mean another $0.50 in per-share earnings, or more than a 41% boost to the current earnings estimates of $1.32 per share.

Bank of America’s Coming Dividend Deluge

Higher earnings means more profit to pay out to shareholders. Bank stocks used to boast some of the most lucrative opportunities for income investors to put money in their pockets. And just as sure as interest rates will eventually rise, bank dividend yields will return to more historical levels.

Before the Credit Crisis, banks paid out as much as half of their earnings in dividends. Back in 2006, BofA paid out 47% of the $4.59 it reported in earnings per share. So while loyal shareholders may lament at just how high earnings and payouts were a decade ago, a return to these payout ratios would be welcome news to current investors.

If the payout ratio returns to past levels, Bank of America’s dividend could be as high as $0.60 per share. This would represent a juicy dividend yield of 4.3%, and doesn’t factor in the potential boost from higher interest rates.

Target Return on Equity

The most important measure of success for a bank is its return on equity, or ROE. The higher the better, and an ROE of 10% or above is considered healthy for a financial institution because it indicates it is covering its costs of capital and generating an adequate return for shareholders (the equity is shareholders’ equity).

BAC’s return on equity will be about 6% this year, if it hits its earnings targets. Next year it could hit 7%, and if interest rates increase as expected, ROE could hit the important 10% hurdle rate.

The company can get there, and the fact some of its peers are already there illustrates the bank’s potential. Wells Fargo & Co (WFC) is considered one of the best run banks in the business and boasts an ROE above 12%. Super regional bank U.S. Bancorp (USB) is also held in high esteem by analysts and bank investors and should log an return on equity above 14% this year.

BAC Trades Below Book Value

The flip side to Wells Fargo and U.S. Bancorp’s success is they are richly valued stocks that have already largely recovered from their Credit Crisis depths. Price-to-book is another valuable bank metric. A general rule of thumb is to buy a bank stock at book value (a P/B ratio of 1), and sell it when it doubles (so reaches a P/B of 2).

Wells Fargo trades at a P/B multiple of 1.5 times its book value. U.S. Bancorp trades at 1.83. BofA? Only 0.64 times its enterprise value. If the stock moves up to trade at the bank’s book value of $22.54 per share, investors could see gains in excess of 50%.

BofA is also currently trading below its tangible book value of $16.17 per share. This is simply puzzling because it suggests that the company is worth more dead than alive. If it closed its doors and settled all its obligations with cash and assets, investors would get more than where the stock is currently trading.

Bottom Line on Bank of America

Bank of America is a bona fide industry leader in the United States. It has the largest market share of checking and savings deposits in the country, is the biggest wealth management firm and is the top mortgage lender in the country. It competes with the likes of JPMorgan Chase (JPM) and Citigroup (C) as one of the largest banks in the country, and world for that matter.

BofA has work to do to cut costs and boost shareholder returns, but it is getting there. Noninterest expense fell to $56.5 billion in 2015, down significantly from $71.5 billion in 2011, while net income is up nearly ten-fold over that time frame as the economy has improved and litigation stemming from the Credit Crisis has finally dissipated.

All considered, BAC stock has upside potential of 50% within a year or two, and could easily double within the next five years.

As of this writing, Ryan Fuhrmann was long shares of Wells Fargo but did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2016/05/bac-stock-bank-of-america-wfc-jpm/.

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