Bank of America (BAC) shares have more than doubled off of their lows seen early last year on the back of improving fundamentals and a rosy outlook for the future. Optimism abounds and pessimism is seemingly absent from the discussion regarding what will become of BAC shares in 2013 and beyond. While the run-up in BAC shares has been warranted, in my view, when everyone is leaning one way, is it wise to follow the crowd?
Some very large names in the financial world have come out in support of Bank of America in recent weeks. For instance, Guggenheim's Marty Mosby thinks that the big banks, Bank of America included, have something like 30% in additional upside in 2013. The basis of his argument is that the big banks will be "let out of the penalty box" that is Federal Reserve action resulting from the financial crisis. This action restricts capital returns to shareholders and Mosby thinks this restriction will begin to come to an end this year. He doesn't expect that the big banks will be given carte blanche immediately, an assumption I happen to agree with, but that the mere thought of the banks being given regulatory approval to finally return more capital to shareholders will be overwhelmingly bullish.
Dick Bove, the renowned bank analyst formerly of Rochdale Securities who now works for Rafferty Capital Markets, has also publicly stated that BAC has 30% upside potential this year from current levels. After pounding the table for big financials for much of the last couple of years, Bove notes a bit of caution is warranted after BAC has more than doubled in the past 13 months. Interestingly, Bove says he's making a contrarian call on the big financials. I don't see it that way as I don't see anyone saying big banks will lose value this year. I'm sure there is someone, but I haven't been able to find a financial bear anywhere.
Bruce Berkowitz has joined the fray as well, noting that BAC's book value should double over the next three to four years. With BAC's current book value at just over $20 per share, Berkowitz implies that BAC's book value per share will reach $40 or more by 2017. With BAC currently trading at just over half its book value, Berkowitz reckons that if BAC can get back to trading for 1X book value, the stock will quadruple over that time period. While Berkowitz is right that BAC is trading at a healthy discount to book value, a lot of very positive things will need to happen for BAC's book value multiple to double in three or four years. I'm not suggesting it won't happen, but this is an exceedingly bullish scenario.
In late January, board member David Yost almost doubled his stake in BAC, buying 20,000 shares. Whenever insiders are getting in on the bullish action, that is always quite encouraging. However, we must temper our enthusiasm with Yost's purchase as $230K is a relatively small purchase given the size of Bank of America. We often see board members of such large companies spend in the millions of dollars but still, Yost must think the stock is undervalued or he wouldn't spend his own money to purchase it outright.
Why are all of these big names so bullish on Bank of America? Fundamentals have undoubtedly improved, the company has deleveraged by a large magnitude, the company is right-sizing its branch network after former CEO Ken Lewis went on a buying binge, and the company is divesting its private equity business. In addition, current CEO Brian Moynihan is downsizing the investment bank (Merrill Lynch) as part of the deleveraging process. This move away from riskier lines of business like investment banking and PE and into more stable, core businesses like mortgages and small business loans has clearly resonated with the investing community. Furthermore, Moynihan said definitively that further capital raises are unnecessary at this point. I think we all knew this already but it is comforting that the CEO of the company is willing to go on record stating as much.
Considering that BAC shares have risen so hastily in the past year or so, caution is warranted before a long position is initiated. In addition, I normally shy away from a company that has nearly unanimous support from bulls, with bears nowhere to be found. This type of herd mentality often marks the top of an asset's price. However, in BAC's case, I think the optimism is warranted. Given that the company is getting back to its core business, that is, acting like a bank, and that the company is seemingly ready to return capital to shareholders via dividends and, eventually, buybacks, BAC shares look ripe for a continued rise in 2013 and beyond. Certainly, the easy money has been made in BAC shares as they bounced from $5 to trade near $12 today. However, the company is still trading for roughly 85% of tangible book value and just over half of total book value. This means that if BAC can simply trade for tangible book value this year, a nearly 18% rise is implied from current levels. Also, tangible book value should continue to rise as BAC continues to improve its profitability this year and in future years. Berkowitz has the right idea in that BAC just needs to keep growing book value as it is, and the share price will follow.