Bank of America shares are up approximately 16% this morning on the news that Warren Buffett is investing $5 billion in preferred shares of Bank of America (BAC). In our view, this is a textbook case of Buffett being greedy when others are fearful.
At BAC's current levels, investors were clearly fearing a massively dilutive capital raise or a bank run. Including today's gains, BAC shares are down more than 38% on the year as investors have become increasingly concerned about the bank's capital ratios. This has been exacerbated in recent weeks by bloggers and conspiracy theorists who have hypothesized that BAC will need as much as $200 billion in equity to make up for litigation costs, mortgage writedowns, commercial real estate and European debt exposure, and goodwill writedowns.
At its current level, price-to--book value is 0.4, or near where the Company traded during the credit crisis. Investors clearly do not believe the value of the assets on the book. While it is doubtful that all of the assets on the book are worth their current value, our guess is that the truth is somewhere in the middle of what the stock is currently pricing in and what the balance sheet says. Further, while net interest margins are compressing, we think BAC can build equity organically over the long term, which should, in theory, lead to a higher stock price. From our standpoint, it helps knowing the world's greatest investor agrees with us, too. Another investor who we have great respect for, Bronte Capital, also came out with an article this morning supporting the bull case for BAC.
We recommend purchasing shares of BAC. We are long via long-dated call options in order to mitigate the downisde risk in the event the market pushes BAC to the point where a dilutive capital raise is required.
Disclosure: I am long BAC.