Seeking Alpha
Long/short equity, value, growth, dividend investing
Profile| Send Message|
( followers)  

Summary

  • We pitch two companies from the banking sector, Bank of America and Bank of New York Mellon, against one another in the latest installment of our Head-To-Head series.
  • The article focuses on the relative strengths and weaknesses of Bank of America and Bank of New York Mellon, based on business performance and dividends/forecasts.
  • It ends with discussion of the current valuations of the two companies, and details whether Bank of America represents good relative value at the current price levels.

Bank of America Background

Bank of America (NYSE:BAC) was founded in 1874, and is based in Charlotte, North Carolina. The company's Consumer & Business Banking segment offers traditional and money market savings accounts and treasury solutions. Its Consumer Real Estate Services segment offers consumer real estate products comprising fixed and adjustable-rate first-lien mortgage loans for home purchase and refinancing needs. The company's Global Wealth & Investment Management segment provides investment and brokerage, estate and financial planning services. Its Global Banking segment provides various commercial loans, leases, commitment facilities and other advisory services. Meanwhile, the company's Global Markets segment offers sales and trading services for securities and derivative products in primary and secondary markets.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance and that pay a decent, well-covered dividend.

We analyze each company relative to the other on the following criteria within each of our two main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins
  4. Quarterly revenue growth
  5. Quarterly earnings growth

Dividends/Forecasts

  1. Dividend payout ratio
  2. Forward yield
  3. Annual EPS growth forecast

Once we have analyzed the two companies based on the first two buckets, we can then assess whether they represent good value based on the current prices of the two stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Forward price-to-earnings ratio
  2. Price-to-book value ratio
  3. 5-year price-to-earnings growth ratio

So, for example, a company that performs well compared to its rival on the first two buckets (business performance and dividends/forecasts) and that is undervalued relative to its peer (based on the third bucket: valuation) could outperform its competitor going forward.

The table below provides the data that we will use to analyze Bank of America and Bank of New York Mellon (NYSE:BK) for the first two buckets.

Stock

Bank of America

Bank of New York Mellon

Business Performance

Return on equity

3.40%

8.26%

Return on assets

0.37%

0.86%

Operating margins

21.10%

27.70%

Quarterly rev. growth

-0.80%

0.30%

Quarterly EPS growth

-42.90%

3.33%

Dividends/Forecasts

Dividend payout ratio

5.00%

23.00%

Forward dividend yield

0.30%

1.90%

Annual EPS growth forecast

86.25%

13.68%

As you can see, Bank of America is a distant second in the business performance bucket. Indeed, its profitability is not currently anywhere near as strong as that of Bank of New York Mellon, since it scores a rather disappointing 3.40% on return on equity and just 0.37% on return on assets. Furthermore, its recent quarterly update showed that the bank is unable to grow the top and bottom lines at present, with quarterly revenue falling by 0.80% and quarterly EPS growth being -42.90%. This is in sharp contrast to Bank of New York Mellon, which was able to post much better quarterly top and bottom line figures of 0.30% and 3.33% respectively.

However, Bank of America excels when it comes to forecasts for next year. Indeed, the disappointment of the recent quarter could fade, as it is expected to deliver earnings growth of 86.25%. While Bank of New York Mellon's 13.68% forecast growth rate is also impressive, it is considerably lower than that of its sector peer. Furthermore, Bank of America has a payout ratio of just 5.00%, which shows that its currently low yield of 0.30% could be much, much higher. This bodes well for investors seeking an income from their investment.

Overall, Bank of America is beaten into second place by Bank of New York Mellon, although we note that next year could be an entirely different story due to the strong forecast growth rates that could be on offer.

Valuation

Due to its strong performance in the first two buckets, it would be of little surprise for Bank of New York Mellon to trade at a premium to Bank of America. Let's see if it does.

Stock

Bank of America

Bank of New York Mellon

Valuation

Forward price-to-earnings ratio

10.36

14.44

Price-to-book ratio

0.67

1.19

PEG

2.38

1.62

Although Bank of America lost out to Bank of New York Mellon in the first two buckets, we feel that the valuation gap between the two companies is too wide. For example, Bank of America trades at a discount of 28.3% to Bank of New York Mellon in terms of the P/E ratio, while the price-to-book ratio of Bank of America indicates that shares are very cheaply priced. Indeed, its ratio is 43.7% lower than that of its sector peer.

Sure, the PEG ratio indicates that Bank of New York Mellon is better value than Bank of America, but we feel that the price-to-book ratio is perhaps the key metric to use, since Bank of America is continuing to post disappointing levels of profit right now. However, that doesn't mean that profitability will not return (as growth forecasts from the first two buckets highlighted), and so now appears to be a great opportunity to buy the stock at a one-third discount to its book value.

So, while we do not feel that Bank of New York Mellon is necessarily overpriced, we do think that Bank of America offers better value than its peer. As such, we think it will outperform its rival going forward.

Conclusion

Bank of America is going through a challenging period at present, as shown by its disappointing quarterly growth figures and lack of profitability. However, we're encouraged by its future growth potential (as shown in the second bucket) and, more importantly, feel it is undervalued relative to its sector peer, Bank of New York Mellon. Sure, Bank of New York Mellon performed better in the first two buckets, but we feel that the valuation gap between the two banks is too wide. As such, we believe that Bank of America could outperform Bank of New York Mellon going forward.

Don't forget to follow Team Money Research and let us know which stocks you'd like to see go head-to-head against Bank of America in future articles!

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Is Bank Of America A Better Buy Than This Peer?