"Buying opportunities and bad news go hand in hand." ~ David Alton Clark
I usually start out a piece with a famous quote from one of the value investing greats like Warren Buffett or Benjamin Graham. But this time I thought I'd make one up of my own. The maxim, "Buying opportunities and bad news go hand in hand," essentially means they exist together and are connected with each other. They occur simultaneously. This is another way of expressing the often used adage, "Buy when there's blood in the streets," coined by Baron Rothschild of the famed Rothschild banking family. Many famous investors employ this technique. Case in point, Warren Buffett is famous for acquiring assets of companies when everyone else is running for cover. Coincidentally, Buffett is long Bank of America (NYSE:BAC) and bullish on the company's prospects going forward as of this writing. In the following sections I will lay out my case as to why Bank of America presents an excellent contrarian buying opportunity with a significant margin of safety.
The bad news is already priced in
The pullback in Bank of America's shares reflects the continued nervousness about the banking industry, economic concerns, regulatory uncertainty, and potential legal liabilities. Not to mention a recent regulatory accounting error that cost shareholders an increased dividend and share buyback program. Shares of Bank of America have been battered as of late, no doubt. The stock has fallen by nearly 20% since the end of March.
(Chart provided by CNBC.com)
Nevertheless, times of turmoil often present the best buying opportunities for savvy investors. Contrarians find their best investment opportunities during major sell offs. One of Buffett's famous quotes is, "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."
A pullback related to headlines and transitory issues often provides the opportunity to buy great names at a discount price. When the weak hands panic and sell out, hopefully you've kept your powder dry and take advantage. Have you ever considered the fact that someone is buying the shares that are being sold? Think about it. Somebody must really want your shares bad right now. The way Bank of America has been attacked so vehemently lately and virtually no one coming to the banks defense actually bolsters my contrarian case.
You must have courage in your convictions and have a long term time horizon to be successful
High risk equals high reward. Investing in Bank of America at this time takes courage in your convictions. Nevertheless, to a contrarian investor, this is just the time to strike. Take the JPMorgan (NYSE:JPM) whale incident, where billions of dollars were lost by the bank in October of 2012.
(Chart provided by Finviz.com)
In retrospect, that was a major buying opportunity in JPMorgan's stock. The stock has essentially doubled, soaring from $30 to $60 per share since the news was released. I cannot say definitively Bank of America's shares will have the exact same outcome. Yet, I do believe the stock is currently undervalued and will bounce back over time.
Bank of America is fundamentally sound with a fortress balance sheet
The earnings report and annual meeting seem like ancient history at this point. This makes the drop in the share price suspect. It's hard to even remember the jubilation experienced after the bank beat earnings handily and passed the stress test with flying colors, isn't it? If I was a conspiracy theorist I would say it looks like someone is attempting to purposefully drive the stock down as much as possible. Nonetheless, it is more likely short term players taking profits and weak hands who unfortunately bought in at the top selling out as their dreams of a quick score were dashed.
The fact of the matter is Bank of America is firing on all cylinders. It's hard to believe I can say that based on the current sentiment regarding the bank. But you know what, it's true. Bank of America has continued to display significant business momentum over the last two years. Several key statistics within the bank's recent earnings report have been overlooked and long forgotten.
Total period-end deposit balances were up $38 billion year-over-year to a record $1.13 trillion. The bank funded $10.8 billion in residential home loans and home equity loans in the quarter. More than 1 million new credit cards were issued in the quarter. Global wealth and investment management reported record asset management fees of $1.9 billion, a pretax margin of 25.6 percent. Global banking average loan balances were up 11 percent year-over-year to $271 billion. Credit quality continued to improve with net charge-offs down 45 percent year-over-year. Need I say more?
It seems market participants have really bad memories. I submit most of the current selling pressure is by investors who have decided they just can't take the heat from all the headlines even though the bank is making great strides where it really counts. The litigation expenses are related to the past and will subside in short order. Once the litigation costs are removed from the equation, earnings will see an immediate boost. Furthermore, the comparisons will start to appear much more favorable. I wonder if this could be the reason why it seems like someone is trying to shake as many shares loose as possible.
Bank of America isn't going anywhere
As the major economies of the world have grown larger over the years so have the major banks to accommodate these economies. Big banks competently expedite trade and investment on an international scale. With the globalization of the world's marketplaces, large scale banks with substantial liquidity are necessary to handle the large scale needs of international markets. So the axiom "Too big to fail" is actually true. Bank of America is too big to fail, as it needs to be, but not too big to succeed as some would suggest. Bank of America is an integral part of the global banking structure and an essential part of US and global economic security. This fact directly mitigates the downside risk for shareholders that the bank may be broken up.
The stock is fundamentally undervalued on a historical and relative basis
The stock is trading for a price to tangible book value of 1.0 versus the industry and peer average of 1.5. This implies the bank may have 36% upside from current levels. That puts the share price at $20.
(Table provided by Scottrade.com)
Furthermore, Bank of America is trading for a PEG ratio of .81.
(Table provided by Yahoo.com)
The PEG ratio is a broadly-used indicator of a stock's prospective worth. It is preferred by numerous analysts over the price/earnings ratio because it also accounts for growth. A PEG of 1 or less is believed to be favorable. As Benjamin Graham would say, "Price is what you pay, value is what you get." I submit Bank of America is the best buy among of all the banks.
A contrarian is one who attempts to profit by investing in a manner that differs from the crowd, when the crowd appears to be wrong. A contrarian believes that a certain herd mentality exists among investors which leads to exploitable mis-pricings in stocks. Widespread pessimism about Bank of America's prospects has driven the price so low that it overstates the bank's risks, and understates the prospects for returning to profitability. Identifying and purchasing distressed stocks, and selling them after the company recovers, can lead to above-average gains. I believe Bank of America currently presents such an opportunity.
I am bullish on Bank of America in the long run. The bank's legal issues are coming to an end. Furthermore, the bank has shown numerous areas of improvement. Bank of America did beat earnings estimate, pass the stress test, is trading for less than book value, has significant core business momentum, a fortress balance sheet and serves a significant amount of households and businesses globally. You have to go against the grain to be successful. With the bank trading at $14.51 and sporting book value per share of $20.69, your margin of safety is more than sufficient at this time. Nevertheless, layer into any position as the market is trading at all-time highs and seem at an inflection point.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BAC over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.