The Bullish Case for Bank of America
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Bank of America (NYSE: BAC) is a complicated organization, with many different business areas and a very complex balance sheet. But the company has been slowly streamlining its assets, and the incipient real estate recovery can be just what the bank needs to definitively leave its worst times behind. At historically low valuations, there are solid reasons to consider a position in this gigantic financial institution.
When analyzing the balance sheet of a company like Bank of America, investors face an almost impossible challenge if they pretend to reach a clear conclusion. Toxic assets, derivatives exposure, and the potential for legal liabilities mean that the true health of these companies is tremendously hard to assess. In Bank of America´s case, its enormous asset base, different business lines and the added problems from the Countrywide acquisition make the situation even more obscure than usual.
But make no mistake, Bank of America may be the riskiest of the big banks, but that uncertainty is already reflected in the stock price. The following table compares financial statistics for Bank of America versus competitors like Citigroup (NYSE: C), Wells Fargo (NYSE: WFC), JPMorgan (NYSE: JPM) and Goldman Sachs (NYSE: GS), and it shows some interesting conclusions.
Bank of America has the lowest Return on Assets and Return on Equity in the table, meaning that both its assets and its shareholder´s equity are generating lower profitability than any of the big US banks, this is clearly a negative reflection about the quality of the bank’s assets.
On the other hand, Bank of America is also the cheapest one as measured by the Price to Book Value ratio. Not only in comparison to peers, but also from a historical perspective Bank of America is trading at a notoriously low valuation.
Each dollar of the company´s equity is trading at dirt cheap levels in the market, mostly because nobody feels too sure about the true value of that equity. One thing needs to be considered though: that value is not static but dynamic, and conditions seem to be improving lately.
Not even Bank of America can have a precise estimate about the true value of its portfolio, and bad loan provisions are one of the ways the company uses to estimate such value. Things have been improving in that regard over the last quarters, and key variables like loan losses reserves and noncurrent loans have been showing a slow but steady progress.
Return on Equity seems to have bottomed last year, and Bank of America looks like it’s finally getting better from the tremendous blow it received during the financial crisis. The company has been raising liquidity and improving its balance sheet for quite some time, and that´s starting to show in the quarterly results.
The bank is not completely out of the woods yet, and a lot of work needs to be done in order to improve the quality and transparency of its assets base. But key macroeconomic variables like real estate activity are showing clear signs of improvement, and that could be a determinant tailwind helping Bank of America to finally move beyond the crisis and recover historical valuation levels.
A bet on Bank of America is a bet on the economic recovery, since the company is widely exposed to economic conditions and still fragile in terms of the quality of its assets. But considering the improvements at the company level, as well as some positive signs from the real estate sector, the risk and reward equation looks certainly interesting. It may be a good time to consider a long position in this dirt cheap US banking giant.
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acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company and has the following options: short OCT 2012 $33.00 puts on Wells Fargo & Company and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Goldman Sachs Group and Wells Fargo & Company. 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.If you have questions about this post or the Fool’s blog network, click here for information.