Bank of America Corp (NYSE:BAC) stock has been a bit frustrating over the past few months. BofA has had an outstanding year operationally. But BAC stock has stalled out, trading sideways since mid-February.
Not even a Q2 earnings beat could move Bank of America stock, which actually traded down for three straight days following the results. For now, however, that’s OK, and investors should stay patient with BofA.
There’s a saying in value investing that “if you take focus on the downside, the upside will take care of itself.” That saying seems to apply well to BAC stock at the moment. That’s not to say there’s no downside in the stock, of course. Any banking stock — and most stocks, period — faces cyclical risk. But in the current environment, BofA seems reasonably well-positioned even to manage choppy waters.
Beyond the downside, there’s simply a lot of good news here, ranging from the imprimatur of Warren Buffett, to steady earnings accumulation, to still-solid macro and credit environments. Those factors simply don’t seem priced into Bank of America’s share price. But once they are, BAC stock has a clear path to $30 and beyond.
BAC Stock and Charge-Off Rates
One of the narratives coming out of big bank earnings last month, for instance, was a steady increase in credit card net charge-off rates. That figure, according to the Wall Street Journal, hit a four-year high in the second quarter. That, in turn, raises fears that even a modest recession could raise those rates — and significantly impact earnings for Bank of America and its peers.
But that four-year high is coming after a period where charge-off rates were abnormally low, as major banks were exceedingly cautious about lending. And over those four years, lending standards have loosened, which isn’t necessarily a bad thing. Adding more credit card debt that yields 15% or 18%, even with incremental charge-off rates of 4% or 5%, is a win for BofA.
Charge-off rates aren’t supposed to be zero. There is some risk involved in lending, but as long as the rewards are greater than those risks, Bank of America will be fine.
And it’s worth pointing out that BofA has the lowest rates of any of the major banks. Data compiled by the Journal shows that its rates were modestly lower than those of Citigroup Inc (NYSE:C) and JPMorgan Chase & Co. (NYSE:JPM), and notably better than those of Wells Fargo & Co (NYSE:WFC). Only American Express Company (NYSE:AXP), which caters to a high-income clientele, had a better rate.
Obviously, macro risk is a part of investing in BAC stock. But the idea that some massive credit event is on the horizon seems exceedingly unlikely. And it’s worth noting that total net charge-offs declined in Q2, and the provision for credit losses fell 26%. BofA also sold its U.K. credit card business, creating a more-focused single-country offering in the process.
The portfolio at Bank of America seems to be in pretty good shape. And that bodes well going forward.
BofA Earnings Continue to Rise
Bank of America earnings are growing nicely. Earnings-per-share rose about 10% in Q2, excluding the gain from the U.K. sale, after 46% growth in the first quarter.
The concern with stocks like BAC always is that earnings growth isn’t coming from better lending, but more lending. If earnings growth is being created simply by taking more risk, it only increases the likelihood of a major credit event coming down the line.
That’s simply not the case here. BofA is managing costs, with its efficiency ratio (operating expenses as a percentage of revenue) continually trending down. A strong market obviously is helping the wealth management business, but BofA Merrill Lynch is also showing strength in investment banking.
In a decent, if not spectacular, U.S. economy, Bank of America simply is performing exceedingly well. It’s growing revenue through what looks like sustainable means. It’s controlling expenses. All of the businesses are executing. As such, earnings are growing, even without help from higher interest rates (which help margins) or from another leg up in the U.S. economy. When those factors kick in, BAC stock seems to have much more potential upside.
Bank of America on Its Way to $30?
BofA is on track to clear $2 per share in EPS in 2018 rather easily at this point. That implies an 11-12x forward multiple for BAC stock, which simply seems too low.
Similarly, Bank of America stock trades at a modest discount to its book value. In fact, it hasn’t traded above 1x book since the financial crisis (except for a brief time in early March).
Both multiples have room to expand along with BofA earnings. The company and the industry are getting back to normal, as I’ve argued before. That in turn sets up a return to 14-15x EPS and some premium to the value of its assets (surely the BofA business is worth something, right?) 14x EPS of $2+ and 1.2-1.3x book value both value BAC stock at $30 by next year. And I continue to believe that’s a very likely outcome for the stock.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.
