Is Bank of America A 'Buy And Hold' Candidate?
Helen 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 one of the world's largest financial institutions, serving individual consumers, small, and middle-market businesses and large corporations with a full range of banking, investing, asset management and other financial and risk management products and services.
The bank was badly hit by the 2008 financial crisis due to its investments in sub-prime mortgage loans, most of it coming from its two acquisitions, Countrywide Financial and Merrill Lynch. It then turned out to be a successful recipient of the TARP, in the sense that it has avoided bankruptcy and was able to pay off the bailout money lent out by the federal government. Recovery will probably continue this year, which makes it a possible, based on its current price, cheap buying opportunity.
The outlook of an upside potential on its stock appears reasonable considering that other people, including me, see an improving trend in the industry key drivers, such as, interest rates, GDP growth and housing market prices.
However, difficult challenges remain that threaten to pull the stock in the opposite direction. Many factors threaten the health of the US economy, such as high oil prices, and the prospect of the full-blown crisis of a war with Iran. Europe also continues to be possibly heading into a recession.
Overall, I’m optimistic that economic recovery will continue to climb although slowly, and with it carrying Bank of America’s stock.
Financial Performance
Bank of America posted a net income for the first time in three years, a sign of improving times. However, its financial performance is still far below its pre-crisis levels. Profit margin fell from around 12.6% in 2007 to about 1.3% in 2011. Going forward, I see the profitability of the bank in the short-term as not exactly certain, in part because of loan loss provisioning and other expenses, such as the agreement in principle with federal and state authorities on mortgage matters in which Bank of America committed about $11 billion, and the usual suits related to the sub-prime mortgage mess. The said agreement suggests additional payables in the pipeline that will affect future cash flows. The good news is that the agreement was one less headache for the bank and may possibly provide a template for settling all the other claims against the bank related to the sub-prime mortgage. In terms of performance, the bank’s net interest margin was maintained at around 2.7% for each of the five years, which is a good indication of long-term profit potential. Another positive indication of future performance is that the economy and home prices, as key drivers of Bank of America’s value, appear to be recovering in the horizon as suggested by the February monthly reading by Fannie Mae. If this turns out to be correct, then there will be a significant upside in Bank of America’s balance sheet. This is because the values of its mortgage securities, real estate loans, and foreclosed assets, are all anchored on home prices.
Valuation
It is not that meaningful to use valuation methods that utilize earnings as the main factor when stocks being examined have net losses. To overcome this I use alternative approaches that can stand in for earnings, such as the price to book ratio. In using price to book, lower is better in most cases, unless something is fundamentally wrong with the company. In this case, Bank of America’s price to book ratio of .44 suggests that it’s cheap, provided that we assume that the bank get its net margin on track. Among the top three biggest banks in the US, Bank of America’s price to book ratio is better than Citigroup’s (NYSE: C) .58 and JP Morgan’s (NYSE: JPM) .94. Its two competitor banks were also severely affected by the mortgage crisis but both have now recovered. In terms of performance, Bank of America is weaker now than both JP Morgan and Citigroup but is seen to be able to catch up to them in the future. Bank of America’s one-year forward price to earnings ratio of 7.14 supports this assessment, which compares well with JP Morgan’s 7.61 and Citigroup’s 7.25. In addition, a 2% return on assets is easy for a bank, in normal conditions. That translates to earnings per share of $4 based on assets of $2,140 billion, which is more than half of the stock’s current stock price. Considering that banking is not threatened by obsolescence or insolvency, I therefore see a good long-term potential for Bank of America.
Conclusion
I think Bank of America is a good buy and hold investment since home prices and the economy will recover someday and then things will eventually smooth out.
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