Large banking institutions don't typically create a lot of excitement among investors. After the near collapse of our financial system in 2008 and 2009, who could blame investors that decide to pass on companies in the financial sector. But Bank of America (BAC) appears to be situated extremely well in the future. Below are 4 reasons why investors should consider adding Bank of America to their portfolio.
Reason #1 - Fundamentals
Bank of America released its latest fourth quarter and annual report on January 17, 2013, before the market opened. One of the major concerns during the financial collapse was the lack of liquidity and cash that some of these banking institutions truly had. Bank of America has done a nice job of growing their cash pile over the past year. The company ended 2012 with almost $923 billion available, an increase of roughly $85 billion from 2011.
Another positive on the balance sheet is that while increasing cash, the company also managed to increase their long term investments. The company increased their long term investments by approximately $69 billion over the previous year. While that might seem impressive by itself, also keep in mind that Bank of America reduced its long term debt by roughly $425 million.
On the income side, Bank of America managed to also generate a net income of $4.19 billion, compared to only $1.45 billion in 2011.
So to summarize, Bank of America was able to increase their cash position, increase their long term investments, decreased their long-term debt, and more than doubled their net income. Clearly the company improved a lot of things in order to have such a stellar 2012.
Reading over the annual report, there were 3 key takeaways:
- Bank of America has narrowed its focus to concentrate on the businesses and services that matter most to customers and clients. The company divested more than $60 billion of assets in non-core activities with no meaningful impact to core earnings and large improvements to capital ratios and liquidity.
- Important to all investors should be the fact that Bank of America reduced risk throughout the company while maintaining a strong risk management culture. Credit risk measurements continued to improve in 2012. Loss rates were at their lowest levels in several years.
- The company improved its work culture by involving employees. They started a program called New BAC. The purpose of the program was to generate thousands of ideas from employees on how to streamline the company, be more efficient in their operations, reduce the red tape within the company, and to decrease expenses.
Reason #2 - Technical
Although technicals should only serve to compliment a company's fundamentals, Bank of America has provided shareholders with significant returns over the past year, as the chart below shows.
The share price has appreciated roughly 35% over the course of the past 12 months. And based on the recent trend, it appears the share price may be consolidating before beginning its next leg up.
During the same time, Bank of America has managed to generate higher returns for its shareholders than some of its main competitors such as:
- Goldman Sachs (GS) has only increased by about 26%
- Morgan Stanley (MS) has only increased by about 23%
- Deutsche Bank (DB) has actually decreased over the past 12 months
- Citigroup (C) has only increased by about 31%
So clearly, on a technical level, Bank of America has been superior. Now let's look at a few more reasons why Bank of America belongs in your portfolio.
Reason #3 - Low Volatility
This isn't a typical reason for investing but it should be. Although volatility may not have a direct effect on returns it can have a direct effect on an investor's mentality. It's much easier to own a stock for the long-term when it doesn't cause a lot of anxiety from one day to the next. And that's where volatility comes in. We want to identify stocks that can excel in the future but do so without large moves down. As the chart below shows, Bank of America's volatility is extremely low and appears to be trending lower as well.
The volatility has clearly decreased over the time frame of the chart. It was once above 53 and has now settled in the high 20s. Not only that, but volatility appears to be trending even lower. This is due to the stellar returns that Bank of America has produced over the past year in addition to the strong fundamentals that the company has generated, giving investors a great deal of confidence.
Reason #4 - Housing Market
We all remember that the collapse of financial stocks was tied very closely to the collapse of the housing market. Well things have changed. The housing market now appears to be making a comeback. It has shown steady improvements in housing prices, housing sales, and the amount of new home building. Because of this increase, banks have benefited because of the amount of people returning to the housing market. In the fourth quarter of 2012, Bank of America was able to generate mortgage originations of $22.5 billion. Wells Fargo (WFC) was the largest beneficiary with $125 billion but Bank of America was able to surpass US Bancorp (USB), who had $22.1 billion, and Citigroup, who had $16.8 billion.
Reason #5 - Capital Reserves
Bank of America's capital is at industry leading levels. The company ended 2012 with a Tier 1 common capital ratio under Basel 1 of 11.06 percent. This is an improvement of more than 3 percentage points from three years ago. The industry was told that by 2019, all companies must meet the requirements of Basel 3 standards. Well Bank of America's Tier 1 common capital ratio at the moment exceeds those minimum standards.
Bank of America certainly does have its fair share of risks. First, its PE ratio at 48, is quite a lot higher than its competitors. So although we earlier identified the chart as being a reason to invest, it certainly is possible that the stock has outpaced its fundamental returns. I don't think that is the case but it is possible. Second, the financial industry is subject to steep declines depending on the economy and housing market. While things look to be in good shape at the moment, things can change quickly as we saw in 2008 and 2009. Investors are cautioned to use appropriate diversification and risk management when considering investments in the financial sector.
Although the banking industry does have its share of risks and Bank of America's PE ratio looks a bit expensive, I think the investment is justified. Bank of America has demonstrated its ability to make radical changes in order to improve its fundamentals. Additionally, both the chart and the volatility indicates investors may be rewarded in the future.