Bank of America (BAC) sure has come a long way in the last five years. Now, it could be getting ready to go even further.
As the mortgage credit crisis was hitting its deepest depths, Bank of America stock was doing the same. In March 2009, the stock bottomed out around $3 a share. The balance sheet was flooded with defaults on its loan portfolio and it faced a very uncertain future.
But thanks to several rounds of government stimulus and some savvy from its management team, Bank of America survived. Today, it's not just surviving. It's beginning to thrive again.
The government's Comprehensive Capital Analysis and Review (known as CCAR) was designed to assess the financial health and capital position of many of the nation's biggest banks in an effort to avoid another potential financial industry meltdown. While most of the big banks like Citigroup (C) and Wells Fargo (WFC) passed the tests, Bank of America's passing grade demonstrates how much better the company is positioned today.
Those test results combined with an improved outlook for the housing market and better overall fundamentals for the company leads me to conclude that shareholders in Bank of America could see as much as a 50% return on their investment over the next 12 months.
Here are some of the factors that support that conclusion.
Bank of America received an unconditional passing grade on the Fed capital adequacy review
Let's just start with the one that was already mentioned. As part of the CCAR process, banks were required to stress their balance sheet under normal market conditions as well as severely adverse ones. The Federal Reserve was clearly satisfied enough with how well the company has capitalized itself to approve its plan to buy back several billion dollars of its common and preferred stock (which we'll discuss a little later).
The Fed approval isn't to suggest that Bank of America is now somehow immune from future economic downturns but it is certainly better equipped to handle them now than they were a few years ago.
Plans to buy back $5 billion in common stock and $5.5 billion in preferred stock
This was one of the bigger surprises of the Fed audit - both because B of A proposed it and the Fed approved it. The market liked it though and this helped push the stock up almost 4% after the news was released.
People may look at the fact that Bank of America didn't propose to raise its dividend when so many other big banks did as a negative. I disagree. The share buyback is the better way to deliver value back to shareholders at this point.
Bank of America stock looks undervalued today according to many measures (which we'll also discuss a little later). Management's recognition that the stock is undervalued means that they're buying back shares on the cheap. Increasing the dividend is a good way to deliver slow and steady value back to shareholders over time but when a stock has the value characteristics and growth potential that Bank of America's does, a broad share buyback program makes more sense.
The stock is currently trading at about 60% of its book value
Bank of America's current price-to-book value ratio rates as one of the best among U.S. regional banks. According to YCharts data, B of A's price-to-book ratio of 0.62 ranks it #63 of 818 financial services companies. For comparison's sake, Citigroup (0.70) ranks #109, JPMorgan Chase (JPM) (0.94) ranks #260 and Wells Fargo (1.34) ranks #525.
Since the stock bottomed out in 2009, Bank of America's price-to-book ratio has ranged from a low of about 0.25 at the end of 2011 to a high of 0.88 in the first half of 2010. So its current value of 0.62 is well within the range. Based on historical data, it's probably not reasonable to expect the ratio to approach 1.00 any time soon but if earnings growth comes in on target, the housing market continues its recovery and investors begin paying higher multiples on its value characteristics, a future price-to-book ratio of 0.80 doesn't seem unreasonable.
The stock price represents a good value by many valuation metrics
Compare Bank of America to several of its peers and its valuation looks compelling using just about any popular ratio.
Its price-to-book value ratio looks very favorable as we've already discussed but its price-to-sales ratio and PEG ratio also seem to suggest that the stock is currently undervalued. The price-to-earnings ratio is more in line with competitors but remains below average when compared to the financial services sector in general.
Earnings and revenue growth forecasts for the 1 and 5 year periods look solid
Total revenue for the bank for 2012 was $84.2 billion. That is forecasted to grow to $90.8 billion in 2013 and to $92.2 billion in 2014. Earnings per share is expected to come in at $1.00 in 2013 and $1.31 in 2014. Analysts are projecting annual growth of almost 19% per year over the next five years compared to the 9% growth forecasts for the S&P 500 (SPY).
In addition, loan loss provisions and number of non-performing loans have dropped significantly over the last few years. All of this suggests that a lot of the excess from the mortgage credit crisis has been worked off of the books and the company is starting to expand its loan book once again which should help drive future earnings and revenue growth.
The housing market is finally starting to show signs of a true recovery
The mortgage market has recently shown some of the strongest signs of life since the meltdown began in 2009. Home prices rose over 7% in the 4th quarter of 2012 and loan originations reached approximately $1.75 trillion for the full year.
Based on the current stock price of $12.57, Bank of America is trading at 62% of its current book value of $20.24.
Based on the factors discussed above, I expect that Bank of America will begin approaching a book value of about $23.00 per share over the next 12 months. Take that number in combination with a price-to-book ratio that could reach 0.80 and your result is a stock price of $18.40 with the potential to hit $20.00 if things go really well.
Throw in the small dividend that B of A is currently paying and you've got a total possible shareholder return of 46.7% over the next 12 months.
Granted, there are some assumptions being made here and not all projections may come to fruition but the potential is definitely there. If Bank of America does deliver on its forecasts, this stock could be a solid buy for investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.