After the Fed updated the markets on its interest-rate outlook for 2019, financial stocks quickly and furiously tumbled. The Financial Select Sector SPDR ETF (NYSE: XLF) fell 4.84% last week. Bank of America (NYSE: BAC) stock fared even worse, falling 7.8% in that time.
Why is the Fed pause bad news for bank stocks in general and BAC stock in particular?
Higher rates would raise interest rates on bank deposits, encouraging banks’ customers to deposit their money in banks. Banks could then lend out those funds and generate profits through the interest on the loans, which would be higher than the interest paid on the deposits.
With no more interest rate hikes in store in 2019, banks now face margin pressure. Even worse is that the Fed’s decision may indicate that there is a slowdown or recession ahead.
And if the macro environment worsens, the Fed may have to lower rates again. That would put even more pressure on bank stocks in general and BAC stock in particular.
The Yield Curve Inversion
Last week, the yield curve inverted, i.e.short-term interest rates rose above the rates on long-term bonds. The inversion signaled that an economic slowdown is potentially on the way. For banks, that could pose a problem for growth in 2019.
In 2018, Bank of America’s revenues barely rose, as its top line increased just 4% year-over-year to $91.2 billion. Its consumer-banking business grew at a healthy pace, rising from $8.2 billion in 2017 to $12 billion in 2018. Its Global Banking and Global Markets units also grew.
But a global slowdown would threaten Bank of America’s growth prospects. And as a forward-pricing machine, markets are discounting the bank’s lowered prospects in light of the potentially worsening conditions.
Source: Bank of America
Buying Back BAC Stock
In February, well before the sharp drop of BAC stock last week, Bank of America raised its $20 billion share buyback program first announced in June 2018. Since the program will be completed by the end of June 2019, the company added another $2.5 billion to the buyback initiative.
In effect, the drop in the number of shares of BAC stock outstanding will benefit existing shareholders because it will put upward pressure on BAC’s earnings per share. BAC already lowered its share count from over 11 billion shares outstanding in 2016 to around 9.9 billion as of the end of 2018.
The CEO’s Compensation Is Too High
While BAC stock will benefit from the buyback, the bad news is that the CEO received a hefty 15% pay raise in 2018. His compensation rose 15% to $26.5 million. It’s worth noting that BAC stock declined last year.
The optics of paying the CEO too much while BAC stock languishes may anger investors. Investors could have voted against the CEO’s compensation, but they may ultimately sell Bank of America stock instead and buy other bank stocks.
Wells Fargo (NYSE: WFC), JPMorgan Chase (NYSE: JPM), and Morgan Stanley (NYSE: MS) are compelling alternatives to BAC stock. WFC and MS stock both have lower forward P/E multiples than BAC stock. JPM stock has a higher valuation because its growth prospects are better than those of BAC.
Bank of America’s 16 consecutive quarters of positive operating leverage is notable. Favorable interest rates also drove its highest net-interest-income since 2015. Although that growth may stall due to the stalling of interest rates, BAC may cut costs, attract more deposits than in 2018 and increase its return on average assets.
The Valuation of Bank of America Stock
The 14 analysts covering BAC stock have an average price target of $32 on BAC, suggesting that the shares can rise about 18.5% from their current level around $27. Tipranks noted that Credit Suisse posted a $35 price target and a “buy” call on the stock last month.
Some investors who compare Bank of America’s valuations to those of its competitors will arrive at a different conclusion. According to an analysis by finbox.io (shown below), BAC stock is close to fairly valued.
The Bottom Line on Bank of America Stock
Wait for the selling pressure on BAC stock to end before considering buying it. The stock could drop further. Ultimately, the economy’s strength this year will enable BAC’s interest income and revenue to rise, although they will increase less than 10%.
As of this writing, the author did not hold shares in any of the aforementioned securities.