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Summary

  • Although Bank of America is not a darling stock after its mortgage woes have persistently refused to dissipate, the company offers opportunity for long-term shareholders because of its ongoing legal woes.
  • The discrepancy between the company's $15-$16 share price and $20-$21 book value should catch your attention as a potential value investment.
  • Gut check: Bank of America made over $11 billion in net profits last year, and is creating $0.30 per share in normalized profits every ninety days.

Very few large-cap American companies trading on exchanges today come close to offering a margin of safety in a truly Benjamin Graham sense. One such value investment remaining in today's market is Bank of America (NYSE:BAC). Due to the lingering effects of mortgage litigation from the Countrywide acquisition in 2008, the overhang of lawsuits has prevented Bank of America from trading at an appropriate range in relation to its book value. The catch, though, is this: to realize the gains, you have to be patient. There's no magic genie that shows up to bring undervalued stocks to fair value instantly just because you bought it.

Incidentally, this is why the bulk of my writing at Seeking Alpha focuses on companies with a much higher dividend yield than Bank of America's current 0.26% offering to investors. Companies that pay nice dividends while being undervalued give you a nice reward for being patient (this insight was the backbone of John Neff's management style when he ran the Windsor Fund at Vanguard). But I believe Bank of America warrants an exception to those general rules because the gap between its current price and fair value is too substantial to ignore.

During the years before the fateful Countrywide acquisition, Bank of America would trade at a valuation equal to or much higher than its book value. When the book value was $24 per share in 2004, the company traded in a range between 58% and 95% above its book value. The cheapest valuation for Bank of America in 2005 was a 64% premium to book value. In 2006 and 2007, Bank of America never got any cheaper than a 25% premium to book value.

Where are we today? Bank of America trades at $15.59 per share while possessing a book value of $20.71 per share. That 28.2% percentage difference between the current price of the stock and its book value is pretty darn close to Benjamin Graham's recommendation to purchase stocks selling for at a one-third discount, putting Bank of America on the short list of companies still truly possessing a margin of safety in its share price.

When Bank of America reported a $0.05 per share loss in the first quarter of 2014, it was all tied to one-time events: the $6 billion mortgage settlement. Otherwise, this is a company that is pumping $0.30 per share in profits every ninety days, and has immense earnings power (last year, despite the constant litany of bad press that the bank receives, Bank of America still netted $11 billion in profits).

This is one of those companies where you take the abstract investing wisdom of being patient and waiting for value to be realized and then putting that notion into actual practice. At some point, Bank of America will revert toward its historical tendency to trade at a slight premium to book value. That alone implies a gain in the 30% ballpark, without even taking into account the growth of Bank of America in the meantime.

And even though Bank of America's return to dividend growth has proven bumpier than first anticipated (the bank revealed $4 billion in misstated notes resulting from the Merrill Lynch acquisition which delayed the bank's initial plans to raise the dividend to $0.05 quarterly and repurchase $4 billion worth of stock), it should be remembered that the bank's financial statements were unaffected by the revision and the bank's capacity to pay a dividend remains unchanged because the concerns from regulators had more to do with Bank of America's management of its profits rather than whether there were enough profits to justify a payout.

To break down my Bank of America thesis down into its most rudimentary form, it would be this: Bank of America is at least 28% undervalued, and my basis for reaching that conclusion is the discrepancy between the $15-$16 share price and the $20-$21 book value. Furthermore, Bank of America has the dividend capacity to pay out at least $0.36 per share in dividends to shareholders in the near future, because its normalized profits amount to $1.20 per share and a $0.36 dividend payout would only be a 30% payout ratio. This stock isn't for everyone, but a patient investor looking for capital appreciation and dividend growth in the next few years might find it wise to give the company a look.

Source: Bank Of America Reminds Us That Value Investing Is Not Popular Investing