At the start of the year, Bank of America Corp (NYSE:BAC) was riding a wave of optimism, as shares had run ahead by almost 45% since early October, fueled by a presidential result that likely meant less regulation in the financial industry. But the momentum has fizzled, and BAC stock has only been able to eke out roughly 10% gains to match the market.
The question is, is the muted year the reality we face, or is this just an opportunity to jump on before BAC stock takes off again?
Me? I’m optimistic.
The Bull Case for Bank of America
Bank of America has a number of catalysts to gin up more capital gains. One of the most encouraging developments is the vote of confidence from Berkshire Hathaway Inc.’s (NYSE:BRK.A, NYSE:BRK.B) Warren Buffett, who collected a $12 billion profit not by cashing out of BAC, but by converting preferred shares into a 700-million-share stake in BofA, making him the bank’s largest equity holder.
In the words of InvestorPlace.com’s James Brumley:
“For those investors that didn’t get into BofA back in 2011 or didn’t get a sweet deal on warrants to purchase the stock, don’t sweat. Everyone has stories about ‘the one that got away,’ including Buffett. Just take the fact that he’s sticking with BAC stock now at face value. He doesn’t have to do that. He’s choosing to do that.”
Also bullish for BAC stock is the bank’s passage of the Federal Reserve’s stress tests. This is an indication that Bank of America has the assets to deal with a major economic downturn. More immediately, it means management has the authority to boost dividends to shareholders, as well as a buyback program.
A simple aspect of BofA that I think gets away from some people is scale. In today’s brutally competitive banking industry that includes not just brick-and-mortar giants but also fintech operators, scale is critical. This allows banks to offer not just competitive rates, but a wide array of quality services that can pull in every kind of consumer and business. What’s more it gives Bank of America the resources to make the necessary investments in cutting-edge technologies, which it’s doing.
So to get a sense of Bank of America’s scale, consider …
- BofA is the second-largest bank in the U.S. with 47 million consumer and small-business customers.
- BAC has a thriving wealth management business, which includes Merrill Lynch and US Trust. All told, they boast nearly 1 million high-net worth clients.
- Bank of America has been investing aggressively in R&D, especially on the consumer-facing end. Consider that BofA’s mobile tech now sports 22.2 million customers.
The key bull argument for BAC stock right now is interest rates (eventually).
The reason is that a large amount of the company’s profits comes from net interest income, which is calculated as the difference between the revenues of the core banking services — such as providing loans — and the costs of paying interest on deposits.
Other trends are favorable, too. Interest on deposits remains fairly low, in part because of the stickiness of Bank of America’s services. Meanwhile, the Federal Reserve has been hiking the fed funds rate — and while that hasn’t led to the upswing in interest rates many thought, that day will come, which in turn will boost income from loans.
The core business has substantial operating leverage, with a 1% increase in interest rates expected to translate into a hefty $3.2 billion in net interest income in a year.
Bottom Line on BAC Stock
Bank of America CEO Brian Moynihan has done a solid job in restructuring and repositioning the company following the 2007-09 financial crisis and bear market. He responded swiftly to the bleeding, cutting costs and unloading non-core assets.
As a result, BofA is in position to benefit from positive trends including a healthy economy and a cooperative Fed. This isn’t just turning into juicy profits, but more cash back in the pockets of shareholders.
And again, Buffett is betting on BAC stock in a big way. The Oracle of Omaha isn’t always right, but I tend not to wager against him.
Tom Taulli runs the InvestorPlace blog IPO Playbook and operates PathwayTax.com, which provides year-round tax services. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.