The recent yield curve inversion has again turned investor attention to financial institutions such as Bank of America (NYSE:BAC). An inverted yield curve means that three-month treasury bills command higher interest rates than 10-year bonds. Such an event often means that the economy will soon enter a recession, creating grave concerns over BAC stock.
Still, at just above $27 per share, the BAC stock price trades at a reasonable valuation. Moreover, with growth for Bank of America stock still forecasted amid the recession, I think investors should hold steady.
Recession Fears Priced Into BAC Stock
Recessions tend to place banks in a bind. Usually, the Fed responds by cutting interest rates. As a result, net interest margins and, by extension, profits, tend to fall. Moreover, in such an environment, fewer consumers and businesses want to take out new loans and losses from defaults also tend to increase.
But here’s the thing: I can say these same things about Citigroup (NYSE:C), JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC). Moreover, BAC’s forward price-to-earnings (PE) ratio of about 8.7 compares well to its closest peers. Only JPMorgan trades at a higher forward PE ratio; however, with JPM’s multiple of 10.1, one can hardly call that expensive.
Profit Growth Estimates Have Not Fallen Significantly
At such a valuation, BAC stock will struggle to move lower. Profit estimates have fallen modestly over the last three months. Analysts estimate a profit of $2.86 per share versus $2.89 per share two months ago. With the inverted yield curve, that estimate could fall further.
However, that still represents a 9.2% increase in profits from the $2.62 per share Bank of America earned last year. Wall Street also projects earnings will rise by 10.1% this year and by higher percentages after that. Moreover, as our own Chris Lau points out, the company continues to cut operating costs, and it bought back $6.3 billion worth of shares.
A recession could still bring growth rates down. For this reason, I do not recommend buying BAC. However, I do not think that justifies selling either. At 8.7 times forward earnings, I think it would take a 2008-like financial crisis to make BAC stock a sell.
Dividend Yield Lags Its Closest Peers
If I were not to recommend BAC stock over its peers, I would do so because of the dividend. Following the 2008 meltdown, most banks have struggled to get dividend payments back on track. To Bank of America’s credit, it has hiked payouts in each of the last five years.
However, the dividend yield on BAC stock comes in at just under 2%. This lags its three closest peers and comes in barely ahead of S&P 500 averages. WFC stock pays a 3.7% dividend yield, though recent scandals increase the risk of owning Wells Fargo. JPM yields around 2.75%, while C stock pays shareholders around 2.55%. For this reason, I see both JPMorgan and Citigroup as marginally better choices than Bank of America. Still, I see little reason for long-term holders of BAC to sell.
Final Thoughts on BAC Stock
Valuations mean the market has priced Bank of America stock at reasonable levels. The inverted yield curve causes concerns for bank stocks — and rightly so. Such inversions have often signaled recessions and the possibility of rate cuts. Both occurrences would weigh on the profit margins of BAC stock and the overall sector.
However, Bank of America stock trades at a forward PE in the single digits. Moreover, analysts still believe profit growth will stay close to double-digit levels. The economy would have to endure another financial crisis for BAC to become overpriced under these conditions.
Other large bank stocks may deliver a higher return due to dividends. However, at the current multiple, BAC stock trades near its fair value.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
