Since the onset of the financial crisis, Bank of America (NYSE:BAC) has resolved the bad loans from its purchase of subprime lender Countryside. However, a healthy balance sheet is not reflected in the BAC stock price. Even as the bank shows record profits, BAC stock is still trading at approximately 9-times earnings.
This summer, it looked like Bank of America stock would finally catch a break. BofA announced a capital allocation plan where it will buy back $30.9 billion of stock in the next 12 months. But the rug got pulled out underneath BAC and all bank stocks.
First, the trade war with China continued to escalate. Second, the Federal Reserve ended a three-year cycle of a tighter monetary policy by raising interest rates. Although its fundamentals still look good, investors have a critical question regarding BAC stock price: will it get some help from the Fed?
Will the Fed Continue Draining the Punch Bowl?
Modest and measured interest rate hikes that started in 2015 and ended in December 2018 gave banks a nice lift. BAC stock rose higher than most of its peers. One reason for this, pointed out by InvestorPlace contributor James Brumley was the banks unusually large amount of non-interest bearing deposits, which account for 23% of its total funding sources.
However, the party for bank stocks may be ending. Investors and analysts widely anticipated the Fed’s rate cut in July. However, as the chief financial analyst for Bankrate, Greg McBride, CFA remarked:
Not only is a quarter point move largely inconsequential to household budgets, but credit care and home equity rates are still notably higher than they were two or three years ago.
Following the rate cut announcement, Fed Chair Jerome Powell would not commit to further rate cuts. However, he wouldn’t rule them out either. Despite uncertainty in the U.S. economy, the uncertainty in the global economy is perhaps a bigger threat. An accommodative monetary policy could affect BAC stock more than others.
BAC Stock Is Priced for Zero Growth
An old saying is there’s a difference between price and value. Right now, by many measures, Bank of America stock does not reflect its intrinsic value. One common measure of intrinsic value is a stock’s book value.
BAC currently has a book value of 1.05. To put that in context, my colleague Will Ashworth cited that when you remove Bank of America, the average price-to-book ratio of the remaining 14 largest U.S. banks (in terms of total assets) is 1.24.
For BAC stock to trade at book value means that investors are not giving the equity a premium to its liquidation price. That means its vast network of branches, bankers, Merrill Lynch, U.S. Trust, and other systems have no bearing on the BAC stock price.
Another factor that should give investors reason to believe BofA is undervalued is its capital allocation plan. Starting on July 1 of this year, BAC intends to repurchase $30.9 billion dollars of stock. That’s approximately $2.5 billion of stock per month.
At the equity’s current price, BAC will be buying about 4.5 million shares each day. If Bank of America stock remains flat, the company will repurchase approximately 1.1 billion shares. That’s about 12% of their total share count (approximately 9.3 billion shares) when all is said and done.
BAC is Likely to See Its Dividend Increase
Banks like Bank of America can only pay out 30% of their earnings as a dividend. This means that for a “big bank” like BAC, stock buybacks are the only other option for diverting earnings.
However, one benefit of BofA buying back 1.1 billion shares over the next 12 months is that the dividend per share should actually increase regardless whether the bank makes a higher total profit. And of course, if GDP continues to grow, BAC profit should as well, which will further increase the dividend payout.
Where Does BAC Stock Go from Here?
The answer to this question will depend, in part, on the Federal Reserve’s upcoming decision on interest rates. If the Fed, as many increasingly expect lowers interest rates again, it is likely to prevent BAC stock from pushing past its current level of resistance.
If, however, the Fed were to hold rates steady, or indicate that any cut would be their last for the year, the stock could push higher. The best advice for investors now may be to hope for the best and plan for the worst.
As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.
