In Search of Value: Funeral Homes & Mega Banks?

John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Legendary mutual fund Guru Peter Lynch once said he loved "hated companies with ugly names in boring, out of favor businesses".  Seems rather intuitive the masses would not pile into companies that fit that dubious description.  And that may imply favorable pricing. Lynch said his idea of a great name is "John Black Funeral Home".

In that spirit, following the 2008 near death experience of  the financial industry--where can you find an uglier, more hated business than banking...specifically, big bulky Mega Banks...more specifically....and its almost painful to say..Bank of America (NYSE: BAC)?!

There's a lot to hate.  Return On Assets of 0.34%, a third of the mediocre Industry Average. Thats not just bad,  its microscopic.  Scared of debt?  Even after recently paying it down, Long Term Debt to Capital is 54.4%, comfortably above the average of large Banks.  BAC customers left in droves in 2009 and 2010.  The bank was the poster child, possibly even the inspiration for, the Occupy Wall Street movement.

A Brilliant Bubble Bath

So why did Warren Buffett, relaxing in his Bath Tub at home in Omaha, come up with the brilliant idea of phoning BAC CEO Brian Moynihan with a plan to invest $5 billion in the struggling behemoth? Better yet, with BAC Bonds yielding 7%+ and BAC Preferred Shares yielding about 8%....why would Buffett negotiate a deal paying him only 6%?  Because he got warrants for 700 million shares he can exercise over the next decade at just over $7/share..... the approximate price at the time of the August 2011 deal.

There is still great value in Bank of America for the patient investor.  With the stock at $9.80, Book Value is $20.40 and Tangible Book Value is $13.48 a share. BAC sells for a 52% discount to Book Value and a 27% discount to Tangible Book Value.  

There are major challenges. Bank of America trails all of its major competitors in revenue growth. Its 2 percent Deposit Growth is a fraction of other Big Banks. And Loan Growth, which Moynihan says this week will be higher this year compared to last year--still trails other large Banks. Comparatively, Bank of America comes up short by almost every metric of Growth. But a Value Investor asks instead "so what do I get for each dollar I invest"? You simply are not paying for Growth.

The risk of overpaying for Bank of America stock appears small.  

Price to Sales Ratio:

Bank of America   0.52%

Citigroup              0.56%

Wells Fargo          1.65%

US Bancorp           2.50%

Investors today price Bank of America stock at just 0.52 times Sales.  Only Citigroup (NYSE: C), among its major competitors, is nearly that cheap.  Wells Fargo (NYSE: WFC), for example, will cost you 1.65 times Sales.  So Investors say each buck of sales at Bank of America is worth about 2/3rds less than Wells.  Better yet, Mr. Market values a buck of Bank of America's sales at one-fifth the value it assigns to each Dollar of US Bancorp (NYSE: USB) sales.  Talk about low expectations!

The Market Says BAC Has a Negative Franchise Value

So the stock market says Bank of America has NO franchise value. The market assigns a Franchise value of minus 27% (discount to Tangible Book).   But what type of businesses sell at a steep discount to Book and Tangible Book ? Businesses with declining Book Value, businesses sucking cash,  businesses that are deteriorating.   BAC's Tangible Book Value not only stopped declining, its been slowly and steadily increasing.  The mortgage write downs are turning into mortgage write ups as the value of BAC's mortgage portfolios have risen sharply with US home prices up 7% the past year. BAC consumer and business lending is up year over year.  Global Wealth and Investment Management is a Powerhouse with assets under management up substantially to $2.3 Trillion.

BAC continues the dirty work of shedding Branches, selling non core assets, eliminating costs, and reducing Employee Count as it trims down to a leaner Operation.  

Analysts expect regulators to permit BAC to return Capital to shareholders in 2013.  Its not unreasonable to expect  the paltry 0.4% payout to increase 5 or 6 fold to 2.0 to 2.5%.  Regulators should acknowledge what Buffett observed recently: Big US Banks "have Capital coming out of their Ears".

And its not like Wall Street hasn't noticed...Year to Date Bank of America is no less than the number one performing stock on the Dow 30. Talk about climbing a Wall of Worry!

Year to Date Bank Stock Performance:

Bank of America UP   76.98%

Citigroup             UP  30.06%

Wells Fargo         UP  18.19%

US Bancorp         UP  16.93%

But  what if regulators determine Bank of America is too big to fail? Or management decides BAC is too big to SUCCEED?  That could be the biggest near term bonanza for shareholders. The question then is--what multiple would BAC assets fetch starting with a baseline of $13.40/share Tangible Book? The average large Bank commands a share price of 1.25 Times Book Value and Merrill Lynch would fetch a good deal more than that multiple.

The obvious big negative is-- BAC seems to face endless litigation risk. But this is widely known and acknowledged and management believes its adequately reserved for that risk.  The challenge for BAC is to step up its profitability and get growth from its core operations.  Higher rates will boost profitability and the company will continue to benefit from an improving US housing market defined by rising home sales and higher prices.   But its not without risk. Especially if housing or the general economy turns south.


Grahdodd has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Citigroup Inc , and Wells Fargo & Company. Motley Fool newsletter services recommend 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus