There’s an attractive and simple case for Bank of America (NYSE:BAC) stock at the moment. Specifically, Bank of America stock simply is too cheap.
The bank’s fundamentals certainly support that idea. Bank of America’s shares trade at just 10.2 times analysts’ average 2020 earnings per share estimate. Their price to book value, as of the end of 2019, was a reasonable 1.25. Between dividends and share repurchases, BofA returned a generous $34 billion to shareholders in 2019, about 11% of its current market capitalization. Investors can expect more of the same in 2020.
But it’s not just BAC stock that looks cheap. Big U.S. banks are inexpensive across the board, and the valuation gap between them and the market as a whole is unusually large.
And yet those big bank stocks for the most part have been declining recently. Since reaching a post-financial crisis high on Jan. 2, Bank of America stock has dropped nearly 10%. That’s a significant move for a stock with relatively low volatility. That trading highlights the risk facing BAC: at its current valuations, its favorable trends may need to get more favorable. It’s unclear how that will, or even can, happen.
Earnings and the Case for Bank of America Stock
The recent selloff of BAC stock doesn’t seem to make much sense. Its fourth-quarter earnings were strong, at least relative to average expectations. Compared with the bank’s performance a year earlier, though, the results don’t look that impressive:its revenue net of interest expense declined 1% year-over-year, and its net income fell about 4% YoY.
But BofA’s results were pressured by the Federal Reserve’s three interest rate cuts last year. Its rate-sensitive net interest margin declined 3% YoY in Q4, In terms of what the bank could control, the news looks good. Chargeoffs and provisions for credit losses both remained healthy. The value of its deposits rose 5%. The bank’s noninterest expense rose only modestly despite wage increases in the wake of labor market pressures.
The bank did get a bit of help from often-lumpy trading revenue, notably in the bond market. Still, overall, it’s hard to fault its trading execution at all. As has been the case for a while, BofA and JPMorgan Chase (NYSE:JPM) look like the two highest-quality names among the major banks, with Citigroup (NYSE:C) steadily improving and Wells Fargo (NYSE:WFC), unfortunately, still performing like Wells Fargo.
Yet despite its strong Q4 report, Bank of America stock has struggled. I wouldn’t dismiss its pullback.
Bank of America’s 2020 Outlook
The worry I see for Bank of America in 2020 is that macro trends probably won’t be in its favor. If the market and economy tank, the stock is going to struggle. In Q4 of 2018, for instance, when recession fears rose, BAC dropped over 16%.
If macro news drives optimism towards the stock market, it’s hard to see BAC, JPM, or Goldman Sachs (NYSE:GS) as particularly attractive picks, at least for 2020. The Fed isn’t going to respond to macro strength with interest rate hikes, not in an election year and not after reversing its 2018 increases so quickly. BofA’s management said on its Q4 conference call that it expected its net interest margin headwinds to persist for at least the first half of 2020, meaning that its next two quarters may very well look like the last one.
There’s still, however, a long-term case for BAC stock; in fact, I’ve made that case in the past. And I missed the late 2019 rally because I thought that the stock was bound to continue trading sideways.
But coming out of BAC’s Q4 results, with the sector as a whole showing some weakness, it’s tough to pound the table too forcefully for Bank of America or for much of the sector. Banks’ 2020 numbers aren’t going to be great. Macro risks still loom. It’s possible this low interest rate environment simply is the “new normal,” which may allow smaller “fintech” players and non-bank financials to try to obtain a higher share of deposits.
Banks are facing real short-term and long-term pressures. The reaction to banks’ earnings seems to reflect those pressures. Put another way, Bank of America stock is selling off because the market is paying attention to what’s going on.
As of this writing, Vince Martin has no positions in any securities mentioned.