Investors Should Bank on This Stock Ahead of Earnings

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

Despite significant macro headwinds, shares of Bank of America (NYSE: BAC) had a phenomenal year, gaining 110% in 2012. Then again, it should escape no one that the bank had nowhere to go but up after getting pummeled in 2011. Be that as it may, this recovery does not happen absent sound execution. And ahead of the bank’s Q4 report, investors want assurances that it will continue.

Q3 Might Be a Tough Act To Follow

Although not a lot was expected from Bank of America in Q3, the bank surprised analysts and raised some eyebrows by posting a break-even profit. Bank of America earned $340 million on revenues of $20.43 billion. This compared to a profit of $6.23 in the year-ago quarter. Likewise, revenue dropped 28%.

The bank earned less than a penny per share, compared with a profit of 56 cents a share year-over-year. As discouraging as this may sound, it actually beat analysts’ estimates, which called for a loss of 7 cents per share. Despite the earnings beat, the numbers could have been better.

The results were impacted by litigation charges, including $1.6 billion to cover part of the $2.43 billion settlement related to the ill-timed Merrill Lynch acquisition. Likewise, the bank absorbed $800 million in charges tied to the re-pricing of certain deferred tax assets due to a cut in the U.K. corporate tax rate. This is in addition to a $2 billion charge related to the value of its debt.

Then again, the bank continues to do well in terms of credit quality. Bank of America’s credit-loss provisions dropped 47% to $1.77 billion in third quarter. This compares with $3.41 billion in the year ago quarter. Likewise, the bank also showed improvements in its global markets division, which improved its bottom line by 35%.

Noticeable improvements were seen in all facets of the operation. The bank also continues to bolster its balance sheet as its Basel 3 Tier 1 common capital ratio rose sequentially by almost 1 point. Basel 3 is a global regulatory standard on bank capital adequacy or a “recurring stress test.”

It serves to prevent “too big to fail” type scenarios by enforcing not only bank capital requirements, but also adding minimum standards on liquidity and leverage. Basel III requires banks to hold 4.5% of common equity. In the third quarter, Bank of America almost doubled that requirement – raising it to 8.97% from 7.95% in Q2. For such an outstanding Q3 performance CEO Brian Moynihan said:

We are doing more business with our customers and clients: Deposits are up; mortgage originations are up; we surpassed 11 million in mobile customers; small business lending is up 27% year over year; loans to our commercial clients rose for the seventh consecutive quarter; and our corporate clients made us the second-ranked global investment banking firm. Our strategy is taking hold even as we work through a challenging economy and continue to clean up legacy issues.

Expectations for Q4

Moynihan was right. For Bank of America, it’s been a hard fought battle towards recovery. But it’s hard to expect a repeat performance in the fourth quarter. And so far, analysts seem to agree as average estimates have dropped over the past three months from 22 cents to 19 cents per share. Likewise, estimates for the fiscal year have also moved down from 65 cents per share to 54 cents.

Then again, rival Citigroup (NYSE: C), which is due to report earnings on Thursday, has also attracted some pessimism - but with good reason. In Citi's Q3, the bank posted $19.4 billion in revenue, representing a year-over-year decline of 7%. Although Citi managed to beat both top and bottom line estimates, Citi has a lot to prove.

On the other hand, that Wells Fargo (NYSE: WFC) performed so well by posting a 24% jump in fourth-quarter profit might be too much for either bank to exceed. Wells beat Street earnings and revenue estimates. The better than expected performance was helped by strong mortgage-banking income and credit as profits totaled $5.09 billion, up from $4.11 billion year-over-year.

Nonetheless, that Bank of America's stock doubled last year, the bank had to justify this level of confidence with its own execution, which it has done to perfection. And the trend shows that Bank of America should have no problems meeting and exceeding estimates as prior uncertainties have been removed.

The bank now has a blueprint toward sustainable growth -- one that investors want to see extended over the next several years. This included a 10% workforce reduction which will impact headcount by as much as 30,000 people. Likewise, the bank’s better than expected string of earnings continues to support its turnaround.

Bottom Line

Although expectations for another double in 2013 are unrealistic, $15 to $18 per share by the second half of 2013 is possible. Remarkably, despite Bank of America’s stellar 2012 performance, shares are still discounted to its tangible book value. The stock is worth a gamble here ahead of earnings and patient investors should begin to take notice.

rsaintvilus has no position in any stocks mentioned. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus