Based on latest earnings, Bank of America (NYSE:BAC) will survive the pandemic. But BAC stock is now a great bargain, trading at attractive valuation levels. It will likely gain more steam once the pandemic passes and a vaccine becomes widely available.
For example, the bank reported excellent earnings for its second quarter ended June 30. Earnings were positive at $3.7 billion, or 37 cents per diluted share. This was despite the impact of a $4 billion reserve hit to earnings from a weaker economic outlook related to COVID-19.
Moreover, the bank stated that its tangible book value per share (TBVPS) is now $19.90 per share. BAC stock trades just 25% above that at $24.99 per share as of August 3. That is an attractive purchase price level for most value investors.
Growth In Tangible Book Value
One reason to buy BAC is that once its earnings come to normal, the bank’s TBVPS will start to rise quickly. For example, analysts polled by Yahoo! Finance expect earnings per share (EPS) to be $1.57 this year and $2.11 by the end of 2021. That is a cumulative increase of $3.67.
So over the next two years, TBVPS could increase by $2.23. This metric is lower than the $3.67 cumulative increase since the bank pays annual dividends of 72 cents per share.
That would reduce the cumulative increase of $3.67 by $1.44 over the next two years. But it could raise TBVPS by $2.23 to $22.13 per share. That’s very close to the present BAC stock price.
In other words, buying the stock now is almost like buying the company for its tangible book value in two or three years. This assumes normal growth using analysts’ expectations and the payment of dividends.
Typically, bank stocks trade between 1.5 and 2 times their TBVPS. That means BAC stock should be around $34.83 per share, or 1.75 times its TBVPS. This represents a potential upside of 39.3% for investors in BAC stock today.
Other Value Metrics for Bank of America
Another way I like to simply value a stock is to compare it to its historical dividend yield. For example, the Bank of America has historically traded at a dividend yield of 1.76% over the past four years, according to Seeking Alpha.
But today, BAC stock is cheaper than at with a dividend yield of 2.88%, as of Aug. 3. Therefore, taking the annual dividend per share of 72 cents and dividing it by 1.76% gives us a target price of $40.91 per share. That represents a potential gain of 63.7% over today’s price.
In addition, Morningstar has a page that indicates that over the past five years, its average P/E ratio has been 13.38 times earnings. Right now BAC stock is trading for 11.8 times the expected $2.11 per share in 2021. That implies that the value of BAC stock should be $28.23 by 2021. That represents a potential gain of 13%.
What To Do With BAC Stock
So here is where we are at. We have three valuation targets based on TVBPS, historical dividend yield and historical price-to-earnings. These targets are $34.83, $40.91 and $28.23, respectively. The average of these target prices is $34.66.
Therefore, the average target price for BAC stock is $9.67 higher than the August 3 price of $24.99, representing a potential gain of 38.9%.
And don’t forget to add in the dividend yield of 2.88%. So the total expected return over the next two years is 44.46%. That represents an average annual return of 20.2% each year.
I believe these are fantastic expected rates of return for most investors. Moreover, the downside is quite limited, especially since stock trades so close to its tangible book value.
I’m not the only one who thinks so. Warren Buffett recently started increasing his company’s stake in Bank of America. Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) presently has a stake of 11.8% in Bank of America.
The Federal Reserve approved the company to take up to a 24.9% equity position in the bank. So, recently Berkshire has added $1.7 billion to its $25 billion position in BAC stock. In other words, Buffett thinks this is a good deal as well.
Therefore, patient value investors should consider buying this worthwhile bank. The expected return should be quite worthwhile over the next several years.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.
