Stock of the Week
Bank Of America
NYSE Symbol: BAC
Price as of 6/3: $15.85
Happy 4th of July. The stock market is starting its fireworks early with the Dow rising over 17,000 thanks to better than expected unemployment data. Pretty much everything is working. Featured stock, Dicks Sporting Goods is up 10% in the last two weeks while featured stock, Celgene is up 30% in the last two months. Utilities, the top performing sector this year has come under pressure this week as interest rates have crept higher. Bonds and bond funds may also come under pressure if rates keep creeping higher. A sector that should perform well in a rising rate environment and a good hedge for rising rates is the financial sector. So far in 2014, the financials have underperformed but could see more interest in the second half of the year. This week we'll feature the financial giant, Bank of America. To many people, Bank of America epitomizes everything that went wrong on Wall Street and in the U.S. During the financial crisis of 2008-09, Bank of America made two ill-advised mergers. Hungry for growth and blind to the mortgage crisis, Bank of America bought two deeply troubled competitors, mortgage lender Countrywide Financial and Merrill Lynch which would have drove them into bankruptcy if not for the federal government. Bank of America borrowed $45 billion from the federal government which has now been repaid. It also has coughed up $60 billion to compensate borrowers and atone for its legal sins, more than any other bank that survived the crisis. Now the nation's second-largest bank-holding company is negotiating with the Justice Department to pay penalties of another $12 billion to settle lawsuits related to the sale of toxic mortgage-backed securities.
But hopefully most of the bad news is in the past. The stock is certainly acting much better. Last year's results provide a glimpse of the bank's earnings power. Bank of America posted a profit of $10.1 billion, or 90 cents a share, up 265% from the prior year, on a 3% rise in revenue, to $89 billion. Analysts are carrying estimates of 92 cents this year and $1.51 in 2015. As earnings have increased, the bank's Tier 1 tangible common equity ratio has rebounded to 7% from a crisis low of 2.93%.
Based on these numbers, the valuation for Bank of America is compelling. Currently the stock trades for 10.7 times earnings, 2 times sales, and 0.76 times book value. The dividend yield is only 0.3% so Bank of America is not a dividend stock (JP Morgan and Wells Fargo are better dividend bank stocks). Bank of America and the rest of the big banks like Citigroup are generating strong cash flow. The government continues to enforce high levels of cash and reserves for the major banks although Bank of America may get permission in the coming months to hike their dividend and buy back shares for the first time since 2008. Once the government eases regulations on the financials to return cash to shareholders investors will have another catalyst to buy the sector. As the fundamentals improve, one analyst and Oakmark fund manager, Bill Nygren have Bank of America earning $2.50 a share in the coming years which means the stock is trading for just 6 times future earnings. Pretty good risk reward at current levels with 50% upside over the coming years if the stock can maintain a PE of 10 times earnings which is very reasonable. In the short term the broader market may be overvalued, but the financials remain undervalued and should start to outperform once again particularly if interest rates are on the rise.