On at least one key metric, Bank of America (NYSE:BAC) stock looks far too cheap. The BAC stock price closed at $26.85 on Wednesday. That’s marginally above the $26.41 book value per share figure the company reported after its second quarter. At a little over 1x book, Bank of America stock would seem to be a steal.
To be sure, it’s not quite that simple. Tangible book value is closer to $19. And while it might seem like the BAC stock price almost by definition would be too cheap at 1x book, that’s not how trading necessarily has played out. Bank of America stock in fact traded below 0.9x book for the entire post-financial crisis period until crossing that threshold in late 2016.
Meanwhile, as I wrote in May, there are external factors at play. And while I’ve been a bull on BAC going back to 2016, I gave up on the bull case above $30 after last month’s earnings report.
In this market in particular, it’s tempting to argue that a 10%+ decline shouldn’t change the investment case all that much. But for bank stocks (and indeed, for all stocks, given that 10% is a nice annual return over the long haul), it does. The questions to ask are if the lower price changes the case enough, and if book value can act as near-term support.
The BAC Stock Price Nears Book Value
On its own, book value isn’t necessarily support for the BAC stock price. There’s $69 billion in goodwill included in the $247 billion total. Bank of America owns $45 billion in derivatives and $246 billion in debt securities carried at fair value. A goodwill write-off or a reduced valuation for the derivatives and securities — neither of which would be a surprise in a recession — would lower book value.
That said, a ratio of 1.01 is cheap. It’s the lowest multiple assigned Bank of America stock in almost two years — with one exception. BAC stock traded below book value last December, as markets plunged. It bounced about 30% the next month.
So an investor can’t look at book value — or even tangible book value — as a floor under BAC shares. But it is a reflection of the asset base here. And value investors or banking bulls can at least argue that the market is giving exceedingly little value, and potentially too little value, to the Bank of America franchise.
The Risks to BAC Stock
One potential way to look at the current P/B multiple is to argue that Bank of America stock almost certainly is too cheap if current economic conditions hold.
After all, this is a company still performing well. It’s up there with JPMorgan Chase (NYSE:JPM) in terms of leadership among big banks. It doesn’t have the seemingly never-ending turnaround of Citigroup (NYSE:C), or the unending scandals that have plagued Wells Fargo (NYSE:WFC). It’s not as exposed to some of the investment banking difficulties that have plagued Goldman Sachs (NYSE:GS), whose stock has fallen below book. It’s an excellent business at a seemingly cheap valuation in a strong economy.
That said, there are risks here. BAC stock has declined not because investors are ignoring the opportunity. It’s declined because those investors are focusing on the risks. A recession would hit Bank of America stock hard — and that’s not an impossible, or even unlikely, outcome.
Indeed, Bank of America itself this month raised the possibility of a 2020 recession to 30%. Its CEO Brian Moynihan talked down those worries a few days later, telling Bloomberg that “we have nothing to fear about a recession right now except for the fear of a recession.”
But that risk is out there, and it’s not the only one. The Federal Reserve already has cut rates. It’s likely to do so again. That will pressure BAC’s net interest margin, and thus the bank’s earnings.
And the big risk is that the two will collide. One of the problems with the Fed cuts now is that there’s little room to cut later. That suggests a scenario where interest rates are pressuring Bank of America’s earnings while the Fed has little juice left to get the economy back into gear. It’s what happened in the first half of this decade — and it’s why BAC was earning well less than $1 per share at the time.
The Bottom Line on Bank of America Stock
Like many stocks outside of tech at the moment, Bank of America stock seems to come down to an investor’s view of the economy as a whole. If recession fears are real, there’s going to be a better entry point than $26 and the current trading makes some sense. If they’re not, the current price is a gift. Investors should place their bets accordingly.
As of this writing, Vince Martin has no positions in any aforementioned securities.
