My three assumptions
The first assumption I made in this projection is that Bank of America will average a 12% return on tangible common equity over the next 25 years. That's higher than Bank of America's profitability of 10.3% last quarter, but it seems reasonable when you consider the trajectory of Bank of America's earnings , the pent-up earnings power that will be realized once its debt ratings improve , and the fact that only a small increase in interest rates ( the Fed Funds rate in particular ) will alone put it over that mark .
The most profitable banks , even in the inhospitable environment they're operating in right now, are able to generate returns on equity well in excess of 12%. Wells Fargo 's in the latest quarter came out to 14%. U.S. Bancorp 's exceeded 17%. The point being, a 12% return on tangible common equity is conservative.
My second assumption is that Bank of America's stock over the next 25 years will trade at an average multiple of 1.5 times its tangible common shareholders' equity. Right now it trades for 1.3 times tangible common equity. In the future, it'll trade for 2.0 or more times the same figure. Embedded in my assumption, then, is that these ups and downs will average out to around 1.5 times tangible book value.
Finally, I assume that Bank of America will allocate its earnings evenly between dividends, buybacks, and retained earnings. This is how banks generally strive to distribute their capital. Relatedly, I also assume that investors in its stock use a dividend reinvestment plan, or DRIP, which automatically reinvests dividends into new shares of the underlying stock.
In sum, while nearly anything can happen in the future -- a world war, a major economic depression, whatever -- these are reasonable assumptions that could just as easily underestimate Bank of America's potential as overestimate it. This is a central reason that Bank of America is my largest stock holding, as I think an 8% to 9% compound annual growth rate is a very respectable return.
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John Maxfield owns shares of Bank of America, US Bancorp, and Wells Fargo. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .