Bank of America (BAC) has been on a roller coaster ride the last couple of years. Even so, I feel BAC is a solid buy right now. Although the bank has doubled over the past year, BAC is still trading three times below its historical average price to book ratio. Moreover, earnings continue to increase. Currently BAC trades for half its book value while the historical average is closer to two. At the same time, EPS is up over 100% and expected to rise by 128% in 2013. At that rate, BAC could easily double again if the U.S. job growth and housing market picture continue to improve. But not so fast. Just because BAC broke above $11 for the first time since July of 2011, let's not get carried away. Please review the following analysis of Bank of America for an in depth review of the stock's upside potential.
In the following sections, we will perform a review of the fundamental and technical state of Bank of America followed by an analysis of the underlying catalysts for the stock to determine what upside exists. The following table depicts summary statistics and Monday's performance for Bank of America. The following charts are provided by Finviz.com, Ycharts.com and Yahoo Finance.
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Price To Book Ratio Review
The bank is currently trading three times below the historical average price to book ratio. Currently, BAC is trading for half of book value when normally it trades for approximately two times book. Now, it's not a perfect Apples to Apples comparison, but is still vastly less than the norm. Who knows, as the saying goes... "records are made to be broken."
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Additionally, BAC offers the biggest discount to book value as compared to its primary competitors.
BAC vs. Competition Price to Book Ratios
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Earnings Per Share Review
As far as earnings per share go, BAC is firing on all cylinders. EPS is up over 100% this year and expected to grow by 128.5% next year. Well-known analyst Dick Bove told CNBC's "Closing Bell" on Monday, "Bank earnings could hit a record $38 billion in the fourth quarter, while the industry is poised to have a solid 2013. Bove noted that industry earnings have risen year-over-year for the past 14 quarters, with banks collectively earning $37 billion in the third quarter. He expects Bank of America, for instance, to pay out 30 percent of earnings in dividends over the next couple of years."
This bodes well for the stock as value and income investors begin to see value being created by dividend increases and stock buyback programs. BAC has a fortress balance sheet with $600 billion in cash and close to a trillion in current assets alone.
Have You Missed the Boat?
The short answer is no. This is may be the start of the next leg higher based on how incredibly undervalued BAC has become. Please review the following one year chart.
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Bank of America was the top performing stock in the Dow this year and the top performing bank in the sector as well. One axiom often quoted on the street is "Price is truth." By this measure BAC is doing very well. My top five banks picks for 2012 were Bank of America up 100%, JPMorgan Chase & Co. (JPM) up 40.91%, Citigroup, Inc. (C) up 39.93%, The Bank of New York Mellon Corporation (BK) up 35.23% and Wells Fargo & Company (WFC) up 31.97%. The following is a chart reflecting their performance over the last 52 weeks.
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I subscribe to the theory of let your winners run until you see a change in trend. BAC is still solidly in an uptrend. Letting your winners run is just as difficult as cutting your losers off. The potential upside created by an improving housing market coupled with the prospects of share buybacks and substantially increased dividends does not appear to be priced in to the stock per the following long-term chart. Nevertheless a shallow pullback is overdue based on the recent performance and would be technically healthy for the stock.
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Fundamentally, BAC has several positives. BAC insider ownership has increased by 51% over the past six months. The company has a forward P/E of 11. BAC has a net profit margin of 6.08%. BAC is trading for approximately 44% of book value. EPS next year is expected to rise by 128% and the company pays a dividend with a yield of .38%. The bank trades for 3.28 times free cash flow and has $10 in cash per share.
Technically, BAC has been looking good. The coveted golden cross was fulfilled earlier this year. The stock has been in a solid uptrend since mid-July. It looks like its ready to take another leg up.
2013 Catalysts Review
U.S. Housing Recovery
According to the National Association for Business Economics (NABE) Outlook Survey, "U.S. housing market recovery will continue next year, with strong gains in residential construction and home prices." The National Association for Business Economics forecast gross domestic product would grow at an average annual rate of 2.1 percent in 2013. It predicted a 2.2 percent rate in 2012. This should more than underpin BAC's top and bottom lines.
Resolution of Legal Disputes
Recent maneuvers by Bank of America could mean a settlement of its legal disputes with MBIA (MBI) is coming in early 2013. The resolution of any legal issues will dispel related uncertainties and lower legal liability risk.
Balance Sheet Strength Could Lead To Higher Return Of Equity
BAC has a fortress balance sheet with $600 billion in cash and close to a trillion in current assets. Trailing two month operating cash flow is $30 billion. The bank trades for 3.28 times free cash flow and less than half of book value. The bank is successfully cutting costs and improving its capital position. This will allow for an increase in the dividend and initiation of a share buyback program, if the Fed approves.
According to a recent Reuters report, independent research analyst Meredith Whitney told clients on Monday "she has turned positive on financial stocks." She upgraded Citigroup Inc, Bank of America Corp and Discover Financial Services to "buy" from "hold." Whitney cited several factors that will lead bank stocks to rise in the near term, "particularly the results of the Federal Reserve's stress test in January," CNBC reported. "Bank of America, for instance, will be able to quadruple its dividend after passing that test," said Whitney.
Bank of America is reiterated a Buy by JPMorgan's Vivek Juneja, with price target raised to $13 from $11.50.
- Bank of America was recently upgraded to Buy from Hold at Stifel Nicolaus.
- Warren Buffett said at the time of his purchase Bank of America is still a "strong, well-led company," and he is "impressed with the profit-generating abilities of the franchise."
- The stock is currently trading above the consensus mean price target of $10.26.
The U.S. housing market may suffer if currently delinquent loans become foreclosures. There are a vast number of loans still on the books where people are several months in arrears. If the economy takes a downturn and some of these people get laid off they may default completely.
The Eurozone sovereign debt debacle could finally implode causing another credit crunch large enough to affect the global banking system.
BAC does not raise the dividend or start a share buyback program which disappoints investors.
BAC's stock runs out of steam as investors take profits and move on after such a large percentage move in the stock.
BAC is trading at a low price to earnings multiple even when taking in to account lower earnings expectations and is trading at several multiples below its long-term norm. On top of that the Fed may allow the banks to return excess capital to investors in 2013. The sector is flush with liquidity and cash.
At this point, I see opportunity ahead for BAC and am staying long. If you are considering buying in to BAC, I would wait a couple days for the stock to cool off some prior to starting a position. Even so, I don't see BAC falling below $10 anytime soon. For this reason I feel the risk/reward equation favors long trades at this point.
Furthermore, the market is currently being held back due to the uncertainty over the resolution of the fiscal cliff. I don't think the politicians will allow us to go over the cliff. They will find a way to make it happen. This will clear the way for the markets to rally.
Finally, the Fed is currently employing quantitative easing which should underpin the markets providing the so called "Bernanke Put." Based on these assumptions I believe the risk reward for starting a position in BAC is favorable.
The Bottom Line
BAC is still oversold and under owned on top of strong fundamentals and catalysts for growth. Bank of America has a fortress balance sheet and strong cash flow providing the opportunity for a share buyback program and/or a dividend increase to be implemented.
The stock is a solid buy at this level if the U.S. housing market continues to improve. It may not double again, yet BAC seems poised for solid growth. My target price is $15 within the next twelve months. If you choose to start a position in any stock, I suggest layering in a quarter at a time at a minimum to reduce risk.
Disclosure: I am long BAC.
Additional disclosure: This is not an endorsement to buy or sell securities. Investing in securities carries with it very high risks. The information contained within this article is for informational purposes only and is subject to change at any time. Do your own due diligence and consult with a licensed professional before making any investment.