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Holy smokes, Batman. Meredith Whitney is at it again!
You'll recall, she's the banking analyst who infamously
predicted in an interview with "60 Minutes" that "hundreds of
billions" of dollars in municipal bond losses would occur in
2011.
She was way off the mark, though. Only about $3 billion in
losses was actually reported. So we gave her the honor of making
The Worst Prediction of 2011
.
Well, fast forward to today, and she's dusting off her crystal
ball again - on Bloomberg Television, no less. This time around,
she's predicting that "
Bank of America
(
BAC
) is the stock to own this year."
Is this just another attention-grabbing media stunt? Or a bona
fide prediction that we should consider acting on? My answer might
surprise you…
The Only Smart Way to Invest
First things first, I need to confess that
my
crystal ball doesn't always work, either. So I can't be too tough
on Whitney.
Take, for instance, my call back in August 2011 that Bank of
America was a screaming "Buy" on the heels of Warren Buffett's
investment.
By the end of the year, shares dropped almost another 30% in
value.
Of course, I did double down on my erroneous call, saying that
Bank of America would "rally mightily in 2012." And it did. In
fact, it ended up being the top-performing stock in the Dow Jones
Industrial Average last year, rising 109.5%.
I bring this up not to brag. Instead, I want to put Whitney's
call into perspective.
It's more about momentum than boldness. And based on the results
of our own personal "stress test" on Bank of America, I'll concur
with her that the momentum will most likely continue. But I
don't
agree with her on how to profit from it. (More details on that in a
moment.)
First, let's cover the six reasons why I expect the bullish
trend to continue for Bank of America in 2013…
~Reason #1: First in, First Out
The banks got us into the financial crisis. So it stands to
reason that they need to lead us out, too. That recovery is
undeniably underway. But given the severity of the downturn, we
still have a long way to go.
Just look at Bank of America's results. In the six years leading
up to the recession, it averaged about $14.5 billion in net income.
Over the last 12 months, though, the company's net income checked
in at roughly $5.5 billion. By that metric alone, profits need to
more than double before we're back to pre-recession averages. And
since share prices ultimately follow earnings, it's not a stretch
to expect that shares could double again, too.
~Reason #2: Top of the Tier
Bank of America has engaged in an aggressive effort to shore up
its finances by restructuring, cutting costs and selling off
assets. In fact, the company remains on track to shed $8 billion in
annual costs by mid-2015.
The end result? Its Tier 1 Capital Ratio, which is the industry
standard measurement of financial stability, currently ranks at the
top of the list for the nation's largest banks, at 9.25%. So if
we're betting on a banking recovery, it makes sense to bet on the
bank that's the strongest financially, right?
~Reason #3: A Building Recovery
We can all agree that the residential housing market is
recovering. It's still in the early stages, though. So as consumers
refinance and take out new mortgages, banks stand to book even more
profits. In other words, the housing market is finally switching
from being a hindrance to a help in terms of banks'
profitability.
~Reason #4: Still on Sale
Even after the impressive run-up last year, Bank of America's
stock represents a good bargain. The forward price-to-earnings
(P/E) ratio of 9.4 is 32.4% less than the forward P/E ratio for the
average stock in the S&P 500 Index.
As Stephen Weiss of Short Hills Capital notes, the stock is
"still" cheap on a price-to-book (P/B) basis, too. Shares currently
trade at about a 40% discount to the industry P/B ratio.
~Reason #5: Institutional Support
When it comes to investing, I typically advise against betting
with the crowd. The one exception? When the crowd is heavy-hitting
institutional investors. The size of their bets provides
much-needed support to share prices.
If you have any doubt, just ask
Apple
(
AAPL
). New
data from
Reuters
suggests that the massive drop in Apple's share price in the fourth
quarter was precipitated by big hedge funds selling out of their
positions.
In Bank of America's case, however, institutional investors are
mostly doing the opposite. For instance, Europe's largest hedge
fund, Lansdowne, purchased 26.5 million shares in the fourth
quarter, according to regulatory filings. Both Adage Capital
Management LP and Arrowstreet Capital LP purchased 14.7 million
more shares. The list goes on.
It's also important to note that these purchases came
after
the stock rose 55% in the first three quarters of 2012. It stands
to reason that hedge funds wouldn't be making such sizeable bets in
recent months unless they expected much more upside ahead. Any
additional purchases promise to provide an additional boost to
share prices, too.
~Reason #6: Dividends, Please
Retail investors' love affair with dividend-paying stocks
continues to heat up. And if Bank of America increases its dividend
this year, which is a strong possibility, it could lead to a
massive influx of dividend investors.
The trick, of course, is being positioned ahead of any such
moves.
Buying Shares isn't Enough
To be fair, risks remain for Bank of America's business. Like
unknown settlement costs for past mortgage practices, continued
deleveraging by consumers and historically low interest rates,
which squeeze profit margins.
No doubt, such factors prompted some institutional investors to
take their profits and run. In the last quarter, hedge fund, Perry
Corp., sold out of its entire 7.5 million-share position.
Meanwhile, other investors, like Boston-based Geode Capital
Management LLC, pared back their holdings by about 10%.
On the whole, though, the investment case for Bank of America
remains much more bullish than bearish.
Whitney expects the stock to top $15 per share in the next six
to nine months. I think that's a conservative estimate. But let's
go with it anyway. Doing so implies that the stock carries about a
25% upside to current prices.
I'm sorry. But that's not enough profit potential to earn a
"must own" distinction from yours truly.
Bottom line: Forget simply buying Bank of America's stock, as
Whitney suggests. If you want to profit from this momentum trade, I
recommend buying just "out-of-the-money" LEAPS options,
instead.
Doing so involves tying up about 90% less capital. So it limits
our downside and frees up capital to invest in other compelling
opportunities.
At the same time, it also increases our profit potential by
putting the power of leverage to work in our favor.
Less risk and more potential profits? Who doesn't want that?
