- The wall of worry regarding Bank of America’s stock continues to grow.
- Downgrades and a myriad of negative articles were posted Monday and over the past week.
- The stock has reached oversold status in the face of the extreme negativity.
- The fact the stock was up Monday in the face of such pessimism is a testament to the stock’s undervalued nature.
Bank of America (NYSE:BAC) currently has more than the company's fair share of the nattering nabobs of negativism, as Spiro Agnew would have put it. Downgrades and negative articles regarding the bank have come out of the woodwork. So much so, it has become nearly impossible to distinguish the long-term buy signals regarding the stock from the short-term deleterious noise. I submit the long-term positive fundamental trends for the bank far outweigh the short-term setbacks. Nonetheless, there are a few drawbacks lurking that could cause the bank some pain. In the following sections I will address the recent negativity and explain why this is actually the time to buy rather than sell.
The signal-to-noise ratio is out of whack
Recent downgrades and a myriad of negative articles posted recently regarding the same set of facts have masked the positive long-term fundamental developments for the bank. According to Princeton University:
"A Signal-to-noise ratio is a measure used in science and engineering that compares the level of a desired signal to the level of background noise. Furthermore, the signal-to-noise ratio is sometimes used informally to refer to the ratio of useful information to false or irrelevant data in a conversation or exchange."
I surmise this is the case with Bank of America at present. In fact, this same phenomenon often occurs with stocks experiencing negative headlines.
Case in point, on Monday MarketWatch published an article detailing a downgrade regarding Bank of America and JPMorgan (NYSE:JPM). Analysts have lowered earnings estimates to "reflect lower expectations for equity and fixed-income trading in the near term." This is the second downgrade in as many days regarding the same set of facts.
Information about a company's trouble or misfortune disseminates much more quickly than good news. The axiom bad news travels faster than good news seems quite apropos. When something bad happens, like Bank of America having to pull the capital return plan, several downgrades and innumerable articles regarding the same event are written and circulated. I posit the speculation surrounding Bank of America's stock is a perfect example of this and has driven the stock to an oversold level creating a buying opportunity.
The stock has reached oversold status in the face of the extreme negativity
"The crowd is most enthusiastic and optimistic when it should be cautious and prudent, and is most fearful when it should be bold. When everybody thinks alike, everyone is likely to be wrong." ~ Humphrey B. Neill
This quote provides a compelling case to buy Bank of America now. Popular opinion often drives investors to sell stocks at the exact time they should actually be buying. It seems some savvy investors have begun to pick up shares as we speak. The stock was up Monday directly in the face on the downgrade.
(Chart provided by Scottrade.com)
Furthermore, the stock is currently bouncing off the bottom of its long-term moving average envelope. On top of that, the on balance volume indicator and the stock's RSI are signaling an oversold status.
(Chart provided by Scottrade.com)
The negative effects of the multiple downgrades and adverse posts regarding the stock are diminishing. The stock is actually up over 1% at the time of this writing. I submit this is the time to buy, not sell.
The long-term positive fundamental trends tell the story
The bank has shown several fundamental improvements over the past year. The following are highlights from the recent earnings report that seem to have been long forgotten in short order.
- Total deposit balances are up $38 billion from year-over-year to a record $1.13 trillion
- $10.8 billion in residential home loans and home equity loans in the first quarter of 2014 were initiated
- More than 1 million new credit cards were issued in the first quarter of 2014
- Record asset management fees of $1.9 billion were reported by the Global Wealth and Investment Management segment
- Global banking average loan balances were up 11% year-over-year to $271 billion
- Bank of America Merrill Lynch maintained a leadership position in investment banking with total fees of $1.5 billion in the first quarter of 2014
- Excluding litigation expenses, non-interest expense was down 6% year-over-year
- Credit quality continues to improve with net charge-offs down 45% year-over-year
Coupled these developments with the fact Moynihan is nowhere near done with his turnaround and cost cutting plan for the bank and you have a recipe for outstanding returns.
Macroeconomic and geopolitical headwinds emerge
If something goes awry in China, Europe or the Middle East the markets will be negatively affected. No stock will be immune. The current "wall of worry" seems to be growing taller. This concern is amplified by the fact the market is still near all-time highs. This is a potent combination.
Legal risks still remain
Bank of America has not yet put the entirety of the company's legal risks behind it. Legal challenges from investors in mortgages and mortgage backed securities could still prevail against the bank.
The housing market falters
With rates on the rise, the housing market could take a hit. The housing recovery is still in its infancy. It remains to be seen if the housing market can withstand higher mortgage rates.
Currently, Bank of America presents a classic contrarian buying opportunity. I submit the bank is on the right track. Nonetheless, based on a series of negative headlines the stock has been sold off wholesale. You have to buy low to sell high. With a PEG ratio of .81, a forward P/E ratio of 9.85 and a price to book ratio of .71, the bank appears undervalued on a historical and relative basis.
(Table provided by Yahoo.com)
The Bottom Line
The majority of the current negative headlines regarding Bank of America are related to the past, not the future. At this point, the risk appears well worth the reward. The time to buy is when others are selling. I believe Neill's quotes and contrarian way of thinking are quite apropos at this juncture. I posit Bank of America's stock is at an inflection point. Virtually no one on the street is recommending you buy Bank of America today. It is hard to think beyond the current state of affairs when negative concerns are repeated over and over.
The conundrum is if you are waiting for all the difficulties creating the so-called "wall of worry" to be solved prior to starting a position, you may never buy a stock. Moreover, by that time, savvy investors have most likely bought in and the stock is no longer a good value. Hopefully, you have some dry powder and can take advantage of this amazing buying opportunity. The fact the stock is up Monday in the face of such pessimism is a testament to the stock's undervalued nature. Even so, I suggest layering in to any position as further headline risk surely lies ahead.