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Summary

  • Bank of America's recent sell-off is unwarranted and has been on no relevant news.
  • Earnings and tangible book value multiples suggest BAC will hit $20 per share over the next year.
  • The sell-off yesterday was due to a smaller jobless claims number, which is an outright positive for bank stocks.

Yesterday's atrocious sell-off of virtually everything was pretty ugly if you're long anything. It was difficult to find anything that was green yesterday, except volatility. No exception to this carnage was Bank of America (NYSE:BAC), as it was hammered three percent yesterday following the terrific jobless claims number (good news is still bad, I suppose?). BAC has been taking it on the chin for the past couple of weeks, as you can see in the one-month chart below.

(click to enlarge)

Yesterday's thrashing was simply the latest giant red bar in BAC's chart for the past month after squeaking above $18 in March. However, I find this sell-off to be overdone, and in this article, I intend to explain why.

To do this, I'll use a DCF-type model that you can read more about here. Essentially, the model uses inputs such as earnings estimates, dividends, a discount rate and a perpetual growth rate in order to calculate the present value of the company's future earnings plus its current book value. For this exercise, I used earnings estimates from Yahoo! Finance and a discount rate of 9.5% to reflect the risk of owning a banking stock in this environment. I also used BAC's tangible book value instead of its traditional book, because I find that to be a better estimation of a bank's true value than traditional book. Finally, I used an estimate of a 20 cent standard increase in the dividend each year. That is trickier with BAC given its recent history, but it is close enough for this exercise.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior-Year earnings per share

$0.90

$1.08

$1.60

$1.76

$1.94

$2.13

x(1+Forecasted earnings growth)

20.00%

48.10%

10.00%

10.00%

10.00%

10.00%

=Forecasted earnings per share

$1.08

$1.60

$1.76

$1.94

$2.13

$2.34

Equity Book Value Forecasts

Equity book value at beginning of year

$13.79

$14.67

$15.87

$17.03

$18.16

$19.29

Earnings per share

$1.08

$1.60

$1.76

$1.94

$2.13

$2.34

-Dividends per share

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

=Equity book value at EOY

$13.79

$14.67

$15.87

$17.03

$18.16

$19.29

$20.43

Abnormal earnings

Equity book value at begin of year

$13.79

$14.67

$15.87

$17.03

$18.16

$19.29

x Equity cost of capital

9.50%

9.50%

9.50%

9.50%

9.50%

9.50%

9.50%

=Normal earnings

$1.31

$1.39

$1.51

$1.62

$1.73

$1.83

Forecasted EPS

$1.08

$1.60

$1.76

$1.94

$2.13

$2.34

-Normal earnings

$1.31

$1.39

$1.51

$1.62

$1.73

$1.83

=Abnormal earnings

-$0.23

$0.21

$0.25

$0.32

$0.40

$0.51

Valuation

Future abnormal earnings

-$0.23

$0.21

$0.25

$0.32

$0.40

$0.51

x discount factor(0.095)

0.913

0.834

0.762

0.696

0.635

0.580

=Abnormal earnings disc to present

-$0.21

$0.17

$0.19

$0.22

$0.26

$0.30

Abnormal earnings in year +6

$0.51

Assumed long-term growth rate

3.00%

Value of terminal year

$7.83

Estimated share price

Sum of discounted AE over horizon

$0.63

+PV of terminal year AE

$4.54

=PV of all AE

$5.17

+Current equity book value

$13.79

=Estimated current share price

$18.96

I won't read the model to you, but you can see that it produces a current fair value of BAC shares of $19 versus today's price near $16, a sizable difference. It should be noted also that analysts have BAC growing earnings at 20.7% in the out years, but I've chosen 10% as a more reasonable estimate of earnings. If BAC were to produce 20% earnings for five years, which is a stretch, to say the least, the upside would be enormous. However, I think half that number is a more reasonable estimate, and even given that, shares are very cheap right now.

It is important to understand that this price is not a price target; rather, it is a fair value. In other words, $19 is the price at which or below shares can be bought today, using my assumptions as outlined above. Shares are cheap at any price below $19, but since the current gap is so large, nearly $3, the model implies shares are very cheap indeed.

If we look at the book value line, we can see that if BAC earns as expected, tangible book value can reasonably be expected to be in the $16 range next year, implying perhaps a $20 share price at a reasonable tangible book value multiple. Or, seen another way, 11 times 2016's earnings would produce a 12-month price target of $19.36, the same area as the tangible book value multiple. We are talking about BAC being valued at 20%+- higher than it is today over the next year, based upon reasonable assumptions, and after BAC's earnings estimates have been slashed over the past couple of months by analysts, there is room for upside surprise.

The bottom line is that BAC was crushed along with everything yesterday in a continuation of a nasty sell-off in the past couple of weeks. The stock has declined $2 on very little news, and I think this represents an opportunity for investors. If you can pick up shares in the $16 range, you will be glad you did over the next year when we see a $20 print for the first time since the crisis. The numbers simply don't provide any evidence that BAC should be trading for $16, so unless Mr. Market knows something I don't, I see a lot of value here.

Source: Bank Of America: Go Home Mr. Market, You're Drunk