Bank Of America Will Continue Its Rise

Sep. 4.14 | About: Bank of (BAC)

Summary

The economic environment is favorable for the banking sector and the economic growth will have a positive impact on banks.

Growth in investments and corporate profits indicates that the incentive to invest is present, which will likely result in more borrowing.

Declining unemployment rate will result in more consumption which is a positive sign for the economic recovery.

Bank of America is getting rid of litigation issues which should remove a major hurdle in the stock price appreciation.

The valuation of the stock looks extremely attractive as it is still trading at a small premium to its liquidation value.

The banking sector has been on a good run over the last few quarters as the economic conditions have been getting better and the banks have finally rid themselves of the demons of credit crunch of 2008. However, we are yet to see a real rally from the banking sector as the global economy and the U.S. economy are still recovering at a slower pace - we might not be far from seeing a big rise in the banking sector stocks as the economic growth is likely to gather pace over the next 12-18 months.

Bank of America (NYSE:BAC) has been behind its peers when it comes to regaining the lost value during the credit crunch - the stock still trades at a substantially lower level than it was trading in 2008. The image below shows the stock price movement over the last ten years.

There have been a number of reasons behind Bank of America lagging its peers in terms of stock price performance. One of the key reasons has been the litigation issues of the company, which I will discuss briefly at the end of the article as I have covered these issues in detail in my previous articles. The focus of this article will be the growth potential of the sector and how well-positioned Bank of America is to exploit this growth opportunity.

Banking sector is probably the most affected by any changes in the economic growth - the business of banks is to borrow and lend money to businesses and individuals. At the moment, it looks like the economic indicators are looking good for the sector. The U.S. economy is expected to gather pace during the current year. According to the OECD, the recovery should gather pace due to strong individual and corporate balance sheets - meaning the improved balance sheets will increase the expenditure and investments from the businesses as well as individuals. Furthermore, the growth in employment is expected to continue and it is likely to go below 6% by 2015. The following image shows the investment and unemployment rates.

The unemployment rate peaked in 2009 and it continues to fall and it is likely to go below 6% during the next year. At the same time, the business investment is following a steep upward trend - this is a hugely positive sign for the economy and the banking sector as most of the investment is done through borrowed funds. The trend in corporate profits is almost identical to the trend in investments, showing that the incentive is there for further investments. The U.S. economy is expected to grow at 2.6% during the current year and at 3.5% during the next year - so, the growth in economy is gathering pace, which is refreshing news for the banking sector.

Let's now talk about the company specific factors - Bank of America's business segments have been showing solid progress over the last few quarters. BAC has been able to improve the quality of its assets and decrease its allowance for loan losses. Furthermore, non-interest expenses have been falling along with the net charge-offs. One of the best performing segments of the bank has been the investment banking segment. This segment is expected to continue its solid progress as the investment banking fees remain attractive due to the increased activity.

Recently, America Movil (AMXL) has hired Bank of America for the sale of its assets - America Movil is the largest operator in Latin America and the company is trying to sell some of its assets to bring down the total number of its subscribers. At the moment, America Movil has 70% of Mexico's mobile subscribers - the company is trying to bring this number to below 50% in order to avoid new regulations from the authorities.

We have looked at the economic environment as well as the company specific prospects - let's now look at valuation. For valuation purposes, I have calculated the tangible book value per share [value of the business after the deduction of intangible assets, such as goodwill] for Bank of America and three of its major peers: JPMorgan (NYSE:JPM), Citigroup (NYSE:C), and Wells Fargo (NYSE:WFC). I have used the company filings for the calculation and all these figures represent the financial position of these companies at the end of the second quarter of the current year. Further, I have made small adjustments where needed. The image below shows the comparison.

Stocks in the sector usually trade at a premium to the tangible book value as this value shows the liquidation value of the business. Normally, a going-concern value is greater than the liquidation value. At the moment, Wells Fargo is trading at the largest premium to its tangible book value, which is understandable as it has had the best stock price performance since the financial meltdown of 2008 - JPMorgan has also shown solid growth and the stock has the second largest premium to its tangible book value while Citigroup is the only stock which is still trading at a discount to its tangible book value - this shows that the investor confidence in the stock is still low. Otherwise, in ideal conditions, the stock will not trade at a discount to its liquidation value. Bank of America is also trading at a small premium, but this premium is nothing compared to its other two peers - BAC has the potential to give substantial gains as the stock narrows the gap on its two peers. As I have said in my previous articles, the biggest hurdle for BAC has been the litigation issues - as these issues are being resolved, I expect the stock to narrow the gap in premium to its peers.

Bottom Line

The economic environment is favorable for the banking sector and Bank of America is well-positioned to benefit from this favorable environment. Almost all the segments of the bank are showing solid growth - rising investment and spending should result in more lending. Furthermore, the most important factor for BAC is that the bank is getting rid of its litigation issues, which should allow it to go up. The valuation of BAC also looks extremely attractive as the stock is still trading at a small premium to its liquidation value compared to its peers. The fundamentals of the business remain strong and I expect BAC to continue its rise over the next few months.

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Additional Disclosure: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

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.