Why Bank Of America Will Trade At $10

Jan.24.12 | About: Bank of (BAC)

For three months, the primary question surrounding Bank of America (NYSE:BAC), the nation's second largest bank by assets, was can it execute its business effectively enough to make any money? It was puzzling to consider that the bank with the largest branch network could not figure out a way to successfully monetize such a great advantage over its competition. Last week, during its fourth quarter earnings announcement, not only did it adequately answer some of these questions, but it offered some insight into what might lie ahead.

The Quarter That Was

By Wall Street's reaction, I can only say that the reported profit of $2 billion for the quarter was a huge surprise, because it came after having posted a loss of $1.2 billion during the same period last year. Its full year earnings arrived at $1.45 billion compared to a prior loss of $2.24 billion in 2010. During the quarter, revenue rose 11% to $25.1 billion with earnings coming in-line with analyst estimates at $0.15 per share. For the market, Bank of America's report should definitely signal that the economy is not only on a rebound, but considering the recent reports from other banks such as Wells Fargo (NYSE:WFC), JP Morgan (NYSE:JPM) as well as Goldman Sachs (NYSE:GS), this just might be the year that the financial sector rises above the rest.

Where Does It Go From Here?

The question now for Bank of America is, can it build on this momentum or will it be back to business as usual? As mentioned previously, it has not yet been able to fully maximize its branch leverage. This is even though that the company reported over $1 trillion in customer deposits - which equates to approximately one out of every two households.

If you couple this with the fact that it has approximately $2.2 trillion in assets, I continue to wonder just how undervalued its stock might still be if it only produces a "decent" return on these assets. By "decent," I'm thinking anywhere between .5% to 1%. On $2.2 trillion, this would equate to net income in the area to $22 billion. With its current market cap, this puts BofA's valuation at just over 6 times earnings. So there is an under-appreciated premium when compared to (for example) Wells Fargo which currently trades today at just over 8.

Last year, CEO Brian Moynihan announced plans that would save the company approximately $5 billion in cost - a plan which included eliminating 30,000 jobs. On Monday, investors received more news regarding the plan intended to help steer the bank toward profitability. In the article from the Wall Street Journal, it discussed the second of the two-stage plan as following:

  • The two-stage plan, which has been dubbed Project New BAC after the bank's ticker symbol, is aiming to make the sprawling banking operations cleaner and more efficient following years of mergers under the previous management. Moynihan has spent much time pledging to investors that he's going to earn a "peace dividend" for avoiding acquisitions and instead get his house in order.
  • Moynihan's work appeared to pay some dividends last week when BofA announced soaring capital cushions, boosting investor confidence in the bank's positions and Moynihan himself. The stock, the worst performer in the Dow during 2011, has rallied 29% this year and was up another 1.4% in recent action. The Phase 1 cuts came out of $27 billion in expenses and Phase 2 will come out of $28 billion.

Summary

How successful this plan will be remains to be seen. But clearly the company has a strategy that it expects to execute and return its brand toward profitability. Investors have to realize that these measures are going to take some time and won't be quick fixes. But certainly it supports the idea that the company has been aggressive in its attempt to turn around its business.

Disclosure: I am long BAC.