Bank Of America Vs. Wells Fargo

| About: Bank of (BAC)
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Summary

When we see a lower PE we assume a lower quality business.

BAC is lower PE than Wells Fargo but has many of its attributes.

The stability and measured growth of BAC is one of its underappreciated strengths.

Bank of America (NYSE:BAC) is considerably cheaper than Wells Fargo (NYSE:WFC). While I like both stocks, investors should be aware that in many ways BAC is very like Wells Fargo and should catch up on its current 15% discount for 2018 EPS.

Leaving the disappointing but destined-to-be-transient reputational problems at WFC aside for a second, we know what makes the bank stand out: high quality income, and lots of it in the sense that WFC has a relatively high level of all income in relation to its assets, a function an integrated product offering and highly evolved cross selling process.

BAC is a global company and contains a significant division called "Global Markets". It's income structure is in the first of the hart below, followed by that of WFC. You see in WFC that its net interest income is growing steadily while its non interest income is generally more stable that of BAC. note that 4A 16 in the WFC chart is adjusted for one off items.

Company data

Company data

None of this undermines the key idea that BAC is greatly improving its operating efficiency and, as happens with companies with low net margins, the gains from this process can be quite dramatic especially when margins should increase anyway due to higher rates and hopefully more robust growth under Trump.

However, part of BAC's relative cheapness might sensibly be attributed to the idea that with its series of "global" divisions and overall jumpier income (both mix and level). Should holders of BAC worry that the stock will hit the ceiling at some point due to it being a lower visibility entity than WFC?

The thing is, if you do give yourself the task of going division-by division you see that BAC isn't so different.

To start off, here is the structure of revenue and costs for 2016 by division:

Company data

Consumer banking and Global Banking (corporate) provide more income than cost for the group. Global Wealth is lower margin, with 24% of group cost by 21% of revenue while global markets is about the same as a percentage of both income and costs. All divisions are profitable - this chart just shows you the contributions the group makeup of revenues and expenses.

Now we can see the contributions, let's walk through the divisions. There is a lot of detail to master here so I am being broad brush. Anyone wanting to dive in themselves, read here.

The big one is Consumer Banking.

Company data

The meat of this division is in its revenue from net interest income, card fees and banking services (deposit account fees included), what I refer to as "core" income. IN all these charts I mean the most repeatable, and sizeable, income lines for each division. And in Consumer, there is growth. 1Q 15 amounted to $7bn, and 4Q'16 amounted to $7.8bn, so the kind of thing you would expect from WFC. The other pleasing trend is that cost/income efficiency improved over the sample timeframe as well. But equally important is the simple stability of this division. All told, Consumer Banking tells a great story of quality and improving profitability.

Here is Global Wealth:

Company data

OK, no growth to speak of, and a high efficiency ratio. But also, this is a serious lack of drama division - high repeat income and cost, so very visible. Not all of WFC is growing if you go through the income lines closely. It rarely is in any big complex bank. If I met BAC management, of course I'd ask them how they might grow GWIM, but its lack of growth doesn't really explain BAC's low valuation.

Here's Global Banking, and we again have some nice, steady growth in the main lines.

Company data

In the income charts above BAC looked much jumpier than WFC. Where does that come from? Enter Global Markets. In fact, this division contains plenty of stable revenue streams as well. It's just one line dominates the overall outcome: trading.

Company data

The key series of bars is the "Core non-trading" series . It's very stable. The trading line (in red) is what moves the overall Core income line (the dark blue bars) either way, quarter to quarter. Asa a result, cost/income measures move around more than in other divisions. This does give you volatile quarters but really only because of one revenue line.

So we have a stock here trading on just over 10x 2018 EPS which has a single main source of volatility vs. the mighty bastion of stability and measured growth (if not recently customer care) WFC.

The only question remaining is how much global markets contributes to profit at BAC.

Company data

So Global Markets is big enough to swing group net income around, though note all other divisions are also growing nicely.

All BAC analysts tend to be conservative in Global Markets trading, simply because the market doesn't want to pay for these earnings.

Conclusion

Right now, BAC on 10.5x 2018 EPS is 15% cheaper than WFC on 12.1x. Back of the envelope, assume the market pays 12x for all BAC earnings except these of global markets, and assume 20% of net income comes from that division going forward (2016 saw 21% net income from Global Markets). You would in that framework be getting Global Markets for free. Alternatively, if the market pays "something" for GM, you are getting discounts on some very nice divisions that would not look out of place next to WFC's main areas of activity in terms of consistency and underlying growth. BAC is very attractive relative to WFC

Disclosure: I am/we are long BAC, WFC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.