Bank Of America: Still A Lot To Prove

| About: Bank of (BAC)

It appeared that I rubbed several readers the wrong way by suggesting that Bank of America (BAC) was trading at a price of a Subway 5$ footlong. It was suggested to me that the price at which a stock trades does not make it a loser and I should look no further than my own proclaimed winner in Sirius XM (SIRI) - which by comparison trades on the McDonald’s (NYSE:MCD) dollar menu. I get that some readers were upset, but unlike BofA, Sirius has put together a string of stellar quarterly reports – during which it raised guidance three times.

When is the right time to buy?

My stance on BofA is widely known. But I’m always looking for points of view that either affirms my belief or forces me to reconsider and rethink that which I believe to be true – which is at this point it is not a sound investment. One of the best arguments on the topic came from an article written by fellow Seeking Alpha contributor Sammy Pollack. He asked when is the right time to buy the stock?

  • The time to buy Bank of America stock is when it breaks the trend of making lower lows and lower highs. A reversal in trend would be signaled if BAC could break above its October highs of $7.43.
  • Buying BAC into weakness is simply too dangerous, while the bulls make a strong case based on valuation they have been making this case from the time when BAC was triple its current price. Some argue that the risk is low because BAC is trading at only $5.50, but this is wrong. Investors in BAC could end up losing everything if troubles in Europe continue.

Sammy made a very good argument in terms of risk. But to me, this question has to involve more than the stock’s current trading price in order to assess when the right entry point might be. This argument was all too familiar when I first established a position in BofA – one that I have since then sold.

Upon my purchase, I saw a stock that had lost 40% of its value upon reaching an intraday high of $10.05 on August 1. At the time, I perceived the primary driver of market hatred toward Bank of America were concerns regarding its balance sheet, one that carries almost $400 billion in long-term debt and makes its net debt position very unattractive. I knew this reason was valid, but I also knew that all banks carry such high levels of debt. These included Goldman Sachs (GS), Wells Fargo (WFC) and Citigroup (C).

It didn’t take me long to realize that BofA’s problems were much deeper rooted. First, it got itself in trouble with poor underwriting and acquisition decisions. Then it exacerbated the problem by looking for shortcuts in its foreclosure process – it just does not seem to learn from its mistakes.

Then there was the public relations disaster when it felt it was appropriate to charge customers $5 per month for using their debit cards for transactions. It ultimately nixed that idea, but only after it was pressured to do so by U.S. Senator, Richard Durbin. With these types of decisions being made by the company, is it possible to safely answer when would be the right time to buy the stock?

Can it run its business effectively

More important than when is the right time to buy the stock, is getting an answer from BofA as to when it will be able to run its business effectively enough to justify a higher trading price. Upon the release of its Q3 earnings results, it reported net income of $6.2B or $0.56 diluted EPS; figures that beat analyst estimates by a significant margin. Revenue rose 6% to $28.7 billion. This deserved a slight applaud when you consider that a year ago it reported a loss of $7.3 billion, or 77.

Conversely, there were several divisions that reported declines in revenue, most of which were in investment banking where revenue fell to $5.22 from more than $7 billion a year ago and $6.80 billion in the second quarter. Although deposits have risen by $11 billion to $422 billion, they were down significantly from last year’s quarter of $427 billion.

There is some evidence that it might be able just run its business effectively enough. But it has a lot of work to do before it turns the corner. The challenge for investors continues to be its risk-reward ratio – and not knowing where the value lies. Clearly it has an invaluable branch network and strong positions in several states spanning the entire US unlike regional banks such as PNC (PNC) or Regions (RF).

However, the benefit of its ubiquity will never get full value if it is unable to run its business and earn its cost of capital. Until then, the right time to buy Bank of America is when Bank of America proves it is worthy of being bought – regardless of share price.

Disclosure: I am long SIRI.