Bank of America (BAC): More Meat On The Bone

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Not too long ago, it was impossible to read financial (or legal) pages without coming across a reference to Bank of America (BAC): they had their turn as the bank that could do no right. That mantel has since passed to JPMorgan (JPM) who seems to face regulatory and legal problems every week.

Given the number and nature of banking regulations and the size and global reach of the big US banks, I doubt that any one of them is transgression-free at any given point in time. When the spotlight falls on them, therefore, it seems like one thing piles on top of another, but, post Lehman Brothers, big banks are resilient things. As I outlined here when talking about JPM, regulatory issues can often represent a buying opportunity for these institutions.

That was definitely the case with BAC, which has more than doubled since the lows at the end of 2011.

 

Given that, my first thought when I look at a chart like this is usually “I missed it!” The big move has already happened and some correction at least is coming. In this case, however, there could well be more meat left on the bone.

BAC and banks in general have been undervalued in many experts’ opinions ever since the financial crisis. The sector has lagged behind others in the recovery, and those using traditional metrics such as P/E and price to book value have been mystified by the refusal of the stocks to gain traction, even as the recovery has continued. Analysts such as Dick Bove of Rafferty Capital have been made to look foolish by looking just at the numbers and predicting significant increases that have yet to materialize.

Those looking at the pure numbers, however, were ignoring the main problem that banks had…people no longer trusted them. This lack of trust was not just confined to a few vocal members of the public; traders and investors felt the same way. There has been a feeling in the market for five years or so that there was another shoe about to drop. As investigations and lawsuits continued, it seemed to be likely that something earth-shattering would be discovered somewhere, and the whole sector would be dragged back down. That hasn’t happened yet and with each passing month and each investigation digging deeper and deeper, it is less and less likely.

I am not one to dismiss feelings and sentiment when making financial decisions. In fact I believe that successful traders and investors pay a lot of attention to intangible influences on price, but they also recognize when the prevailing perception is changing and act accordingly. Such recognition is rarely evidence based. It is usually based on anecdotal evidence and “feelings,” so is dismissed by many analysts. Those analysts were still declaring Apple (AAPL) cheap at $700, and Lehman Brothers cheap just before they went under. The “feeling” that AAPL was overvalued and that Lehman was in real trouble was dismissed as just a feeling, without hard numbers to back it up.

My feeling here, based on conversations with people both in and out of the market, is that sentiment towards the banks is changing. JPM’s troubles are seen by many to be politically driven and have had the perverse effect of actually generating some sympathy for the giant Wall Street bank being investigated. If banks begin to be seen as victims rather than criminals then that negative sentiment that has held back their stock is gone.

Feelings, as I say, are important, but usually in the short term. Over time, a company’s stock price depends on its profitability, growth prospects and financial soundness. In the latter, it is hard to fault BAC. CEO Brian Moynihan has stressed Tier 1 capital ratio at the bank since before he was required to do so, with his “Fortress Balance Sheet” strategy. BAC’s Tier 1 Capital Ratio (a measure of a bank’s risk profile and stability) is above average for US banks in general and significantly higher than the average for mega-banks with a capitalization of $1 Billion +.

The problem with getting to this point is that, in matters financial, profit is simply a reward for risk. By allocating a portion of revenue to risk free or low risk assets in order to strengthen the balance sheet, BAC has limited their profit potential. Having reached the desired level, it is reasonable to expect profitability to increase from here. Prospects for growth and profitability look good as this process has already begun, with BAC reporting positive earnings’ surprises in three of the last four quarters.

That may not be the case this time, but whether it is or not, a case can be made for buying BAC in front of the numbers. Citibank (C) reported this morning, and missed expectations, largely due to lower bond trading profits than expected. A similar report may come from BAC tomorrow, but the feelings I mentioned should put a floor on any resulting drop. Should they match or beat expectations, however, a quick move up to the 2011 highs just above $15 would be likely. If that level is breached, then the next stop is around $21.

It would seem obvious that a major company, trading at around 11.4 times earnings, well below the market, is worth buying. Until quite recently, however, that hasn’t been the case as perception, fear and feelings outweighed fundamental analysis. The only way to counter a feeling is with a stronger feeling, and I have a strong feeling that things are changing and fundamental analysis will finally become the driving force for BAC. If that is the case, then the move up has a lot further to go.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Banking and Loans , Stocks

Referenced Stocks: AAPL , BAC , C , JPM

Martin Tillier


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