I’ve been pounding the table for Bank of America Corp (NYSE:BAC) for most of this year. And while it took a bit of patience, the BAC stock price finally broke out in September.
BAC stock has climbed nearly 30% just since Labor Day. It’s jumped a sizzling 144% since hitting $12 back in July 2016. Those gains alone in the typically stodgy consumer banking sector might make investors at least think about taking profits at this point. And there are some potentially concerning issues that on their own might lead to a pullback in the BAC stock price.
But I think there’s enough good news here to keep from changing my tune. I argued just three months ago that BAC stock was one of 10 to buy and hold for the rest of your life. A 25% gain since then is a good start, but I don’t think the gains here are finished.
The Economy and BAC Stock
As always, it’s important to understand the risks facing a stock. Beyond the standard risks in the banking model — seen on a massive scale in 2008-09 — BAC does have a few concerns.
Most of the gains in BAC stock since the election have come from earnings multiple expansion, not earnings growth. The Fed raised rates again this week and still expects three hikes next year. That should be good news for financial stocks like BAC, but at this point, those hikes look more than priced in.
In that context, then, any slowdown in economic growth in the U.S. over the next few quarters could be a “double whammy” for Bank of America.
First, delinquency rates in credit cards and even mortgages could spike, hitting earnings and book value. In addition, that slowdown could lower expectations for a rate hike. That in turn lowers expectations for Bank of America’s lending spread, which would also hit earnings.
So one change, as the BAC stock price has moved from year-to-date lows around $22 to a current price around $29, is that it is pricing in a lower risk of a macro pullback. And on an operating basis, there are concerns as well.
Two Key Areas to Watch
The two biggest worries for Bank of America are its credit-card unit and its trading volume. As Bloomberg pointed out last week, BofA’s credit card market share has weakened over the past decade.
As Luce Emerson highlighted back in September, JPMorgan Chase & Co. (NYSE:JPM) has taken a significant number of high-income millennial customers away from American Express Company (NYSE:AXP) with its Sapphire Reserve card.
That’s only part of the JPM share gains cited in the Bloomberg report. In addition, Capital One Financial Corp. (NYSE:COF) has surpassed BofA as well.
But BofA has at least admitted to the challenges and set out to answer them, including with an improved rewards program. Charge-off rates remain low, giving the company some flexibility to either ramp rewards and/or take modestly larger risks with the portfolio. It’s not as if the business is plunging; BofA simply needs to compete better. I expect it to do so.
The other concern is trading income. CEO Brian Moynihan told a conference trading revenue would decline 15% in the fourth quarter. BofA at least isn’t alone; a JPM executive made a similar prediction the same day.
The issue there is lower volatility overall and lower fixed-income trading and spreads. But BofA isn’t losing market share; the problems are widespread. And in year nine of an extremely strong bull market, and with low interest rates keeping bond yields down and prices up, those problems shouldn’t be a surprise.
Higher interest rates may help here, too, and at some point, volatility should return to asset prices, which is a potential offset to profit weakness concerns if that volatility accompanies some macro jitters.
BAC Stock Isn’t Expensive
Those worries aren’t immaterial, and I can understand why Emerson argued late last month to take profits in BAC. But the fact remains that BAC stock still is cheap, and there’s still plenty of good news.
BAC still trades at just 13.5x 2018 EPS estimates. Those earnings should grow, even if trading profits and the credit-card business stay muted, if only due to help from some level of normalized interest rates.
The price-to-book multiple has expanded to 1.2x, breaking above 1x for the first time since the financial crisis. But that book value should rise over the next five quarters as well, and historically the BAC stock price traded above 1.5x before the crisis hit.
There are concerns, but there is good news here, across the board. The loan portfolio appears to be in outstanding shape, with charge-off and credit-loss provisions both stable. There’s room for improvement in credit cards and fixed income.
Rate hikes will help lending spreads. And a recent $5-billion expansion of the company’s share repurchase authorization will boost shareholder returns and offset the dilution from the Berkshire Hathaway Inc. (NYSE:BRK.A,BRK.B) warrant exercise. (It also shows the financial strength that regulators, who had to approve that repurchase, see in BofA.)
All told, I’m not bailing on BAC stock just yet. I wrote in August that there was a path to $30 for the BAC stock price, and I see no reason to back off just shy of those levels. There are risks here, but that’s true of every stock. Even after big gains, those risks are well worth taking.
As of this writing, Vince Martin has no positions in any securities mentioned.