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There Still Are so Many Great Reasons to Buy Bank of America Stock

BAC has rallied - but it's still cheap

The news has gotten much better for Bank of America (NYSE:BAC) stock of late. Bank of America stock touched a 15-month low back in December, but the New Year has been good to BAC stock, which has gained 17%.

Bank of America Stock BAC stock

From a broader perspective, however, BAC still looks a bit disappointing. It’s about 12% off 52-week and post-crisis highs reached back in March 2018. And there’s a strong case that Bank of America stock should retake those highs.

Indeed, BAC stock still is cheap. It only trades at 1.17x book value – a significant discount to pre-crisis valuations. More impressively, Bank of America stock trades at just 9x 2020 EPS estimates.

There are reasons why the valuations remain muted. But those risks seem overblown and worth taking, particularly at the current valuation. Bank of America stock might have rallied so far this year but it should have further to go.

The Case Against BAC Stock

There are three core worries when it comes to Bank of America stock. The most obvious concern is that, at some point, the U.S. economic expansion is going to stall out. The bull market has been going for a decade now, as has the economic recovery. History suggests that the tide will turn at some point.

When it does, earnings for big banks like BofA and JPMorgan Chase (NYSE:JPM) should fall. Even ten years on, the memory of the financial crisis remains fresh in investors’ minds.

The second worry revolves around interest rates. Persistently low rates have limited the net interest margin of big banks, the spread between what they pay depositors and earn from borrowers. An inverted yield curve seen last year raised red flags, and was a big reason why BAC, JPM, Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C) all plunged to 52-week lows.

Finally, the political situation looks potentially more worrisome. Democrats have taken the House, and a field of 2020 presidential candidates seems to favor greater regulation for banks. Given that the banks themselves have argued post-crisis regulations already are too stringent, the fear is that earnings will face further pressure if Democrats take power.

The broad theme among these key risks is that they suggest that earnings for Bank of America are at, or at least near, a peak. And so a growing business is trading for 10x 2019 earnings but for good reason.

The Problem with the Problems

But I still think that growing business is one of many attractive at a cheap multiple, as I wrote just this week. One big reason is that the worries cited by BAC bears are somewhat contradictory.

For instance, assume that regulations have pressured earnings by keeping bank lending activity down. That must in turn mean that banks aren’t lending like they were in 2005 or 2007 and that the effect of a macro slowdown will be more muted. Indeed, that’s the entire point of Dodd-Frank and other post-crisis efforts: to make banks more like regulated utilities (admittedly, given the recent experience of PG&E (NYSE:PCG) stock, that may not be the best analogy at the moment).

So it’s an awfully narrow argument to claim that BofA earnings aren’t high enough at the moment and yet will plunge in a recession. For the most part, it should be one or the other, barring a massive macroeconomic downturn. If regulations are affecting the risk profile for big banks, that should mean the sector is less exposed to macro cycles.

Similarly, interest rate pressures are a real concern but they should normalize at some point. Of course, investors last year sold stocks (including bank shares) when Treasury yields rose, anticipating that those higher rates could slow down the economy.

Here, too, it’s a bit of one or the other. If rates rise, so should BofA profits – even if there is macro cost. If rates don’t rise, the economy should be able to muddle through enough to at least justify a double-digit earnings multiple.

Bank of America Stock Should Be Fine

Admittedly, there’s still a bearish scenario that can play out here. If the economy does turn south on its own, Fed rate hikes stop and the central bank could indeed start cutting rates again. That would pressure lending spreads at the same time defaults presumably would rise. And BAC stock likely would take a hit in that scenario.

But what stock wouldn’t? That basic risk is part and parcel of most of the market at the moment. In that context, Bank of America stock looks attractive. It’s cheap. The downside should be somewhat limited barring a significant macroeconomic reversal. And for all the external noise, earnings continue to grow nicely, while credit metrics look strong.

There’s no reason, even accounting for the risks here, that BAC can’t merit a mid-teen earnings multiple, which could push the stock as high as $40 over the next 18 months. Even if that bullish scenario doesn’t play out, a return to last year’s highs still suggests almost 20% upside. That’s more than enough reason to buy Bank of America stock.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media,

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