Bank of America Missed Earnings: Buy It Anyway

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Bank of America’s (NYSE: BAC) earnings missed analyst estimates. Bank of America reported earnings of $0.21 per share. Analysts, on a consensus basis, were expecting earnings of $0.22. Bank of America was the only bank, among the systematically important ones, to miss earnings. The decline in earnings came from the decline in revenue from its Consumer & Business Banking Segment. The company saw an increase in the amount of its deposits without an increase in lending or leasing.

Results about the same as everyone else

Bank of America’s results closely mirrored that of its competitors. The company was able to grow bottom line earnings, even as top-line revenue declined. The company will be shedding its head count in order to generate earnings growth. Bank of America, like JPMorgan (NYSE: JPM), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC), was unable to generate revenue growth. The large banks either reported small advances in revenue, or small declines in revenue. Another noticeable theme is that large banks were able to grow bottom lines by a large margin this quarter. Citigroup was able to grow basic EPS year-over-year by 27.82%, with Wells Fargo growing EPS by 22.37%, and U.S. Bancorp reporting year-over-year EPS growth of 7.35%. Bank of America, on the other hand, generated 600% year-over-year EPS growth. The company reported the highest rate of EPS growth among its peers.

Bank results

The larger banking institutions have been able to avoid the court-room. This has kept legal costs under control, which has contributed to bottom line growth. Bank of America reported a decline in its non-interest expenses, from $19.14 billion in 1Q12, down to $18.15 billion in 1Q13. The allowances for loan losses decreased from 3.61% in 2012 down to 2.49% in 2013. The company saw improvements in its lending portfolio, as net charge-offs have declined from 1.80% in 1Q12 to 1.14% in 1Q13. The decline in charge-offs, along with declining litigation-related charges and declining loan loss allowances, has led to the bottom line growth. The banking business environment is starting to stabilize, and organic revenue growth is coming back into the mix.

Housing starts have been increasing due to household formations and improving demand for housing. Banks will be increasing lending in future accounting periods, based on construction data for housing. This should lead to increasing interest income from loans in the immediate future.

The CEO, Brian Moynihan, plans on sustaining net-income growth by cutting back costs by an additional $8 billion through 2015. Investors are willing to pay a 28.3 multiple on earnings, due to the anticipated cost-cuts that are likely to generate substantial bottom line improvement. The bottom line improvements is the primary earnings catalyst going forward.

Peer comparisons

JPMorgan offers the lowest P/E multiple among the major four banks, but the downside is the bank's risk to exposure to the credit markets. JPMorgan has demonstrated an inability to properly structure derivative risk portfolios in the past with its London Whale disaster. That being the case, investors who have the patience to see the stock trade at a much fairer valuation than 8.7 times earnings over multiples should buy the heavily under-valued bank.

Citigroup's global scope and over-expansion into foreign markets was met with some inefficiencies. In the past, Citigroup sold off certain divisions in order to improve "efficiency." Going forward, Citigroup's business empire will be focused on stable growth, rather than randomly opening business units in every corner of the world.

Citigroup is similar to Bank of America, in terms of having a higher P/E multiple (17.04). This is driven by the high rates of bottom line growth. Bottom line growth will be driven by cutting costs. Citigroup's improving macroeconomic environment (declining loan loss allowances) furthers the justification for buying the stock. Analysts, on a consensus basis, anticipate Citigroup to grow earnings by 21% in fiscal year 2013.

Wells Fargo is the safety play in the peer group. Investors gravitate to the stock due to the "high-quality" management. Wells Fargo trades at a 10.58 earnings multiple because analysts, on a consensus basis, anticipate earnings growth of 9.80% for the current fiscal year. Stocks trade at lower earnings multiples when forward earnings growth is low.

Wells Fargo could cut costs further to improve earnings, but the company's current profit margin of 23.12% is the highest it has ever been over the past five years. Earnings growth was driven by cost-cutting. There is a limit to how much a bank can cut costs before it runs out of ways to reduce the size of its expenditures. Therefore, Wells Fargo is a mature bank stock that offers an attractive dividend yield of 2.69%. Investors should anticipate stable yield growth going forward.

Conclusion

Bank of America is a deep-value investment. Analysts, on a consensus basis, forecast earnings growth of 22.30% on average for the next five years. The higher growth rates will be driven by falling costs, organic revenue growth, and share repurchases. Analysts estimate earnings per share at $0.98 for fiscal year 2013, a 292% growth in earnings over the previous fiscal year. The high multiples on earnings are more than justified, which is why I remain optimistic on the bank going forward. Any pull-back in the stock is a window of opportunity to add to the position.


Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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