I hate to say it, but I think Warren Buffett and the rest of the crack investment team at Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) have run out of good ideas if Bank of America (NYSE:BAC) and BAC stock is their second-largest holding.
As of Berkshire’s Aug. 4 filing, the holding company now owns 11.9% of Bank of America, worth a cool $28.2 billion or 11.4% of its $246.6 billion equity portfolio. If you’re Berkshire shareholder, take solace in the fact the company’s Apple (NASDAQ:AAPL) stake is almost four times as large.
I don’t think you have to be Warren Buffett to know Apple’s growth potential is much higher than Bank of America’s. But I digress.
Buffett might own a big chunk of Bank of America, but that doesn’t necessarily make it a buy. Here’s why.
BAC Stock Hasn’t Been Great in 2020
There are seven financial stocks in Berkshire’s top 10 holdings. Cumulatively, the seven stocks account for 30.5% of its overall portfolio.
Buffett’s Top 10 Holdings – Performance YTD
| Company | Market Cap |
Year to Date Total Return |
| Apple | $1.89T | 54.4% |
| Bank of America | $236.5B | -23.6% |
| Coca-Cola (NYSE:KO) | $206.4B | -12.3% |
| American Express (NYSE:AXP) | $84.0B | -17.3% |
| Kraft Heinz (NASDAQ:KHC) | $42.6B | 10.8% |
| Wells Fargo (NYSE:WFC) | $105.3B | -52.0% |
| Moody’s (NYSE:MCO) | $51.6B | 14.7% |
| JPMorgan (NYSE:JPM) | $318.7B | -25.9% |
| U.S. Bancorp (NYSE:USB) | $57.8B | -35.4% |
| Bank of New York Mellon (NYSE:BK) | $33.9B | -22.8% |
Source: Morningstar.com, data through Aug. 10
The seven financial stocks have an average year-to-date total return of -23.2%, 40 basis points less than Bank of America’s total return so far in 2020. The three non-financial stocks have an average total return of $17.6%, primarily on the back of a fantastic performance by the maker of iPhones.
Now, if you take out Wells Fargo and Moody’s (the worst and best returns of the financial services companies), the average falls to 19.1%, putting Bank of America squarely in the underperforming category along with JPMorgan, etc.
Financial services companies of all types have generally done poorly in 2020. The iShares US Financial Services ETF (NYSEARCA:IYG) has a YTD total return of 16.1%. That’s 300 basis points less than the average for the five Berkshire holdings, and 750 basis points less than BAC.
So, if Buffett were to hedge his bet and buy iShares’ ETF, Berkshire shareholders would be much farther ahead in 2020.
Why BAC Shares Are Cheap
Two of the latest InvestorPlace articles about Bank of America both suggest Buffett is on to something.
Mark Hake believes that once the bank’s earnings return to normal in two or three years, its tangible book value per share (TBVPS) should be $22.13 a share. Its share price, based on a typical multiple of 1.75 times TBVPS, would be $38.73, for a compound annual growth rate of 15,4%, using a midpoint of 2.5 years.
Hake goes on to suggest that Bank of America typically has a dividend yield of 1.76%. At the moment it is 2.64%. My colleague points out that based on a historical dividend yield of 1.76%, BAC should be trading at $40.91, providing 52% potential upside.
InvestorPlace’s David Moadel recently discussed the fact Buffett picked up some more BAC stock as an argument why it’s too cheap to ignore.
“Historically, BAC stock has been a good one to buy and hold after it crashes. If you’ve been trading for a while, you might recall the mind-numbing collapse in the BAC share price from $50 in early 2007 to less than $7 in 2008,” Moadel wrote on Aug. 4.
“All these years later, BAC stock hasn’t gotten back to $50, but it was chugging along smoothly at $35 early this year. Then came the coronavirus, and BAC shares tumbled down to the $18 area in March.”
Now trading around $27, it’s trading at just 16.9 times its forward price-earnings ratio, and 12.8 times its trailing 12-month P/E ratio, the lowest point in the past five years.
The Economy Is Still Fragile
The last time I wrote about Bank of America was in mid-June.
At the time, I wasn’t interested in where its share price was headed, but rather in expressing support for the bank’s Merrill Lynch financial advisors. They were under pressure from management to produce new business in an operating environment that made it very difficult to attract customers.
I’ve spent a decent amount of time writing about the financial advisor community in my not-to-distant past. While there were some really bad apples among the people I interviewed, there were also some professionals who cared about their customers and helped them reach their financial goals.
Most of my colleagues believe that once the economy gets back to normal, the big banks will all return to making lots of money. I tend to agree. That’s especially the case with BAC, who wisely lowered the number of financial advisors getting pay cuts in June as a result of not hitting specific financial targets.
Ask a restaurant owner or a retail store manager how easy it is to grow sales over last year in the middle of a pandemic. Impossible would be the answer. Merrill Lynch is an essential part of the bank’s growth. To irritate the brokers in this environment would set the bank back immensely, in my opinion. Wisely, it changed its mind.
Bottom Line on BAC Stock
Down the road, Buffett will probably look like a genius loading up on Bank of America stock. I’m not nearly as confident about its long-term prognosis. The banks have generally underachieved since 2008.
Under $20, BAC is a bargain. Around $27, I think it’s fairly valued. If you’re buying for three to five years, I don’t see a problem buying its stock. Just don’t expect to get rich quickly.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
