Should Long-Term Investors Buy Bank of America Stock After the Rate Cut?

Long-term investors who bank on BAC stock are likely to be rewarded

On Sept 18, the Federal Reserve cut interest rates by 25 basis. The expected move came amid concerns about trade wars and a potential economic slow down globally. Yet Fed officials were divided about the decision — as well as over the need for any future cuts. Variables such as interest rates, economic growth, global political and trade worries and activity in the housing markets can impact a bank’s stock price. Therefore, today I’d like to discuss the outlook for Bank of America (NYSE:BAC), one of the largest banks globally, and BAC stock.

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Right after the interest rate announcement, there was increased volatility in the equity markets. Initially, broader indices fell after the decision.  Toward the close of trading, stocks rebounded. The recovery was led by banks and the big tech. Although I like BAC stock for a long-term diversified portfolio, I expect market volatility to continue for several more trading sessions.

In case of further pullbacks in BAC stock in the coming days, investors may consider buying into Bank of America shares on the dip. Here’s why.

BAC Stock and the Economy

The outlook given by Bank of America as well as CEOs of other major corporations in recent months shows that the economic or banking cycle in the U.S. isn’t at its most attractive point. Our economy had fired on almost all cylinders for a number of years. Now it may be poised to glide onto a slower growth trajectory.

Bank stocks are exposed to economic ebb and flow. If you are considering buying banking stocks, it’d be important to remember that two main factors affect a bank’s revenue and earnings:

  • Interest rates: As interest rates increase, a bank can earn more money from its loan portfolio.
  • Economic activity outlook: In a robust economy, more money circulates through the system, fueling a bank’s non-interest income.

In short, if the U.S. economy cools down in the coming months, Bank of America stock is likely to be adversely affected. Despite the potential economic headwinds, it is not quite possible to know if or when we will enter a recession in the coming quarters.

Interest Rates and Bank of America Stock

Bank of America stock’s income is divided into two main categories: net interest income (NII) and non-interest income.

Like other banks, BAC stock earns income on loans and other interest-earning assets. It pays interest on deposits and other interest-bearing liabilities. We can arrive at the bank’s net interest income by deducting interest paid from the total interest earned.

In general, decreasing interest rates mean headwind for banks including Bank of America as lower interest rates put pressure on NII and margins.

The low interest rate environment in the U.S. has indeed had negative impact on BAC stock’s net interest income. On July 17, Bank of America released Q2 earnings. Although the bank still expects to see growth in the face of expected interest rate cuts and slower economy, management lowered its full-year guidance of NII.

During the conference call, Chief Financial Officer Mr. Donofrio cut 2019 NII growth outlook to 2%, assuming interest rates stayed stable. He said that if the Fed were to cut interest rates twice in 2019, then the BAC’s NII growth would be about 1%.

Several of our readers may well remember that earlier in April, Bank of America had already cut its NII growth outlook to 3% in a stable interest rate environment. Since the release of Q2 earnings in July, we have had two Fed rate cuts, one in late July and one this week.

At present, Fed’s rate-hike cycle is over. However, we do not know if the central bank may cut rates further. One can even argue that we have some ambiguity over future Fed rate decisions. In other words, later in the year, if there is another rate cut, then BAC stock’s earnings from loans could even suffer further.

BAC Stock Has Attractive Valuation Levels

In the U.S., the Bank of America serves about 66 million consumers and small business clients, giving the bank an attractive deposit base. It has over 4,350 retail financial centers and plans to increase that number in the coming quarters. The group’s online and mobile banking operations are also growing fast, adding to increased fees charged for banking activities.

Due to extensive expense-management measures over the past several years, Bank of America’s efficiency ratio has improved (i.e., gone down). It now stands at 57.48%.

A decrease in the ratio means that the bank has incurred lower costs to generate every dollar of income. For banks, the objective is to get the efficiency ratio as close to 50% as possible. This respectable overall number by BAC shows how effective management’s cost-cutting initiatives have been.

The efficiency ratio is calculated by dividing the BAC’s non-interest expenses by its net revenue. Non-interest expenses may include personnel salaries and other related expenses, marketing costs, and real estate rent, etc.

Furthermore, the trailing P/E ratio for BAC stock stands at an attractive 10.7. And value investors may be interested to know that its price-to-book (P/B) ratio is 1.14.

P/B ratio is used widely to value for asset-heavy companies, such as banks or other financial institutions. In general, for banking stocks, a number below 2 could imply good long-term value. However, investors should due further due diligence by looking at other metrics, too.

Where BAC Stock Price Is Now

Year-to-date, Bank of America stock is up over 21%. However, over the past several months, BAC stock has been trading in a range, between about $26 and $31.

BAC stock’s 52-week range has been $31.37 (Sep. 21, 2018) and  $22.66 (Dec. 24, 2018). In other words, we are at the anniversary of last year’s highest level.

The share price is now hovering around $30, where there is substantial resistance from a technical point of view. If Bank of America stock cannot go and stay over the 52-week high of $31.37 soon, there will likely be profit taking in the stock. Then, I’d expect the stock to fall toward $27.50 level, where it will find initial support.

I would not advocate bottom-picking in case of near-term price weakness. Yet, I find Bank of America stock to be a buy candidate if the price declines toward $27.50 or even lower. If BAC shares can build up momentum, then investors are likely to push to price to a new high in the last quarter of the year. By the end of 2020, long-term investors may indeed see the price reach $34-$35.

Meanwhile, BAC shareholders can also enjoy a dividend yield of about 2.4%. In Q2, the bank paid a dividend of 18 cents per share, representing a 20% increase over the prior-year quarter. Management also continues to buy back shares, which supports Bank of America stock price.

The Bottom Line on BAC Stock

In the coming weeks, BAC stock, like many other stocks in the broader market, is likely to be impacted by the rhetoric of the U.S.-China trade wars as well as global growth worries. Therefore, I expect further volatility in the share price, especially until the next earnings expected to be released on Oct. 21. However, long-term investors may consider buying the dips in BAC shares.

As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.

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