The old Wall Street adage about owning bank stocks recommends that investors buy bank stocks at one-half of book value and sell bank stocks at twice the book value. For investors seeking an intriguing value play, it has been interesting to observe just how much Bank of America's (BAC) post-crisis valuation in terms of book value has deviated from its pre-crisis valuation in terms of book value.
In 2001, Bank of America had a book value of $15.54 per share, and traded at twice that value at some point during the year.
In 2003, Bank of America had a book value of $16.63 per share, and traded at twice that value at some point during the year.
In 2005, Bank of America had a book value of $25.32, and almost hit a high of twice the book value when it crossed the $47 threshold.
In 2007, Bank of America had a book value of $32.09, and the company's stock price hit a high of over $54.
As we sit here in 2013, Bank of America has a book value between $20 and $21 per share. The stock price continues to trade in that $11.50-$12.50 range at a little more than one-half the company's book value.
Bank of America has traded well below its own book value for the last couple of years, but what makes the company particularly interesting now is the fact that the firm's balance sheet has continued to get cleaner, the Tier 1 Capital Ratio has reached satisfactory levels, the company is much more liquid than it was three years ago, and CEO Brian Moynihan has aggressively sold non-core assets since taking over the helm. It is interesting to observe how Bank of America's maligned reputation remains intact even as the fundamentals of the company have gradually started to tell a different story.
A lot of the litigation problems are behind the company. For $2 billion dollars, it looks like a lot of Bank of America's headaches from selling mortgage loans to Fannie Mae from the early 2000s to the beginning of 2009 have been settled. It looks like the amount of repurchase claims have been reduced in half from a little over $30 billion to $13-$16 billion. When you remove the lawsuits related to Fannie Mae from the picture, it looks like the company has about $10 billion worth of lawsuits to settle. For what it's worth, analysts project that Bank of America will ultimately have to pay out about one-quarter of the total lawsuit amounts outstanding. In my opinion, we're moving toward that point where Bank of America will begin reporting truly normalized earnings.
Bank of America looks particularly intriguing from a dividend-growth perspective. Part of Bank of America's attractive valuation is likely due to the fact that the dividend payout is still artificially depressed at $0.01 per share. In Wayne Gretzky parlance, buying Bank of America would be an attempt to "skate to where the puck is going to be." The median analyst prediction is that Bank of America will be earning $1.50 in 2017. If one-third of that could reach the pockets of shareholders, we could be looking at a dividend yield of 4% relative to the capital deployed today. If those dividends and earnings materialize, there could be some substantial capital appreciation as well.
By the way, I am not trying to suggest that every investor reading this needs to own a bank stock. With banks, nothing is guaranteed. Even Wells Fargo (WFC) and US Bancorp (USB) had to cut their dividends during the financial crisis - if you're approaching retirement (or don't want to deal with reading bank balance sheets or exposing yourself to the kind of 75-90% declines that banks experienced during the financial crisis), the road to financial independence does not require bank stops along the way.
That's not just a glib statement. We're fortunate to live in a country that has an economic engine worth trillions of dollars. There are so many ways to get rich in this country without owning banks at all. I'm being serious.
For instance, since 1970:
$1,000 invested into Johnson & Johnson (JNJ) would have turned into $208,000.
$1,000 invested into Coca-Cola (KO) would have turned into $191,000.
$1,000 invested into Procter & Gamble (PG) would have turned into $172,000.
$1,000 invested into Exxon (XOM) would have grown into $382,000.
Never forget that. You don't have to go outside your comfort zone for the sake of diversification. If you do not understand something, don't buy it. Bank balance sheets can be notoriously complex. You have to keep up with Tier 1 Capital Ratios, earnings quality, and liquidity levels. Bank investments require active monitoring. If that does not interest you, you will probably thank your future self for staying away.
However, for investors looking for an intriguing bank investment that could give shareholders significant capital appreciation and future dividend growth, Bank of America is an interesting possibility. Compared with traditional book value techniques, Bank of America is very cheap. The cloud of lawsuits is just substantial enough to keep the valuation down, but is clearing up in such a way that investors may be thinking in 2015, "I wish I didn't wait for a cheery consensus to invest in this company." From a dividend perspective, future shareholders may be rewarded as the payout level is raised and earnings continue to grow. For investors looking to take a risk, Bank of America at $12 offers an intriguing opportunity over the next five to 10 years.