Bank Of America: Buy It Now Before This Ship Sails

Summary

• Last month, we suggested buying Bank of America at $21. Since then, the shares have skyrocketed.
• Yet the bank is still well off its previous highs and offers good value here, given the likely ramp-up in dividends in the next few years.
• The ship is leaving the docks. If you haven't bought yet, you might want to before it sails.

Written by Sam Kovacs

Introduction

Just less than one month ago, when Robert and I shared our model "All Weather Dividends Portfolio" on Seeking Alpha, we selected Bank of America (NYSE:BAC) as our All Weather financial stock of choice. At the time, the stock was trading at $21 and yielding over 3.3%. We agreed that I would write an article suggesting that dividend investors should buy BAC at such bargain prices. But, within just a few short weeks, the stock is up 30%.

Such hectic stock market movements might make your head spin. You might think you've missed the boat.

Source: Open Domain

This might have been the case for some of the stocks we suggested buying. Yet BAC was so undervalued when we suggested buying it a month ago that the current price would still warrant a purchase.

BAC has a dividend yield of 2.56% and trades around $28.11. Based on our MAD Scores, BAC has a Dividend Strength score of 93 and a Stock Strength score of 77.

This article will present and discuss the factors which show why I believe that dividend investors should invest in Bank of America.

Source: mad-dividends.com

The V-shaped recovery which most thought was impossible has occurred. Robert and I have been agnostic in so far as the movement of stock prices is concerned. Yes, the stock market is now disconnected from the economy. Yes, overoptimistic expectations are baked into this market. Yes, that frightens us.

Yet we remain committed to being net buyers of stocks in all environments. The trick lies in investing in dividend stocks which fit in nicely to our strategy. (You can read more on our strategy in our article "Dividend Investing For Individuals Like You & Me").

Our approach might confuse some investors, but for those who "get it", it gives a framework which makes managing a dividend portfolio much more straightforward, removing much of the guesswork from the process.

For instance, it is thanks to this framework that I sold V.F. Corp. (VFC) between $85 and $90, to then purchase it back in the $50s avoiding dire downside risk and increasing my income on the position by more than 60% in the process.

The very same framework tells me that, even after rallying 30% from our purchase point back in May, BAC is still a buy now. But if this market continues in the same direction, you'll miss the boat.

Dividend Strength

At the forefront of our framework is the concept of dividend strength. It encapsulates both the concepts of dividend safety and of dividend potential. The former ensures that we don't invest in stocks which are likely to cut their dividends. The latter ensures the dividend will contribute significantly to total returns and to our dividend goals; it can be considered as the combination of current yield and dividend growth potential: the higher the yield, the lower the required dividend growth, and vice versa.

Dividend Safety

28% of Bank of America's earnings are paid out as dividends. This is a more attractive payout ratio than 72% of dividend stocks.

BAC pays 9% of its operating cash flow as a dividend, putting it ahead of 85% of dividend stocks.

	31/03/2016	31/03/2017	31/03/2018	31/03/2019	31/03/2020
Dividends	$0.2000	$0.2900	$0.4400	$0.5700	$0.6900
Net Income	$1.25	$1.70	$1.77	$2.69	$2.45
Payout Ratio	16%	18%	25%	22%	29%
Cash From Operations	$4.19	$-0.53	$6.25	$1.49	$7.57
Payout Ratio	5%	-54%	8%	38%	10%

Click to enlarge

Source: mad-dividends.com

During the past 5 years, BAC's net income per share has just about doubled, yet in the meantime, the dividend has more than tripled. How should this be understood? After cutting its dividend to just 1 penny per share in 2009, BAC has been aggressively ramping up the amount it pays out each year since 2016. Yet, at 29% of earnings, we can all agree that the dividend still has lots of room before it would be considered unsafe.

Following the Great Financial Crisis, the scrutiny on banks and increased regulation has changed the nature of their operations. The higher reserves add in a margin of safety, and even after a tough Q1 in which BAC was forced to increase reserves considerably, it still earned more than twice the amount paid in dividends.

To quote management in the latest earnings call:

But in terms of the dividend, we kept the dividend payout ratio below 30% of the sort of normalized earnings level and we did it for a reason that one of our operating principles is we wanted to maintain a dividend. And given what we know, we have earned twice the dividend this quarter at $0.40 versus $0.18 payout ratio and we expect that to continue

BAC's dividend is very safe. I do not believe it will come to be cut.

Dividend Potential

Bank of America's dividend yield of 2.56% is higher than 45% of dividend stocks. While the yield is quite lower than the 3.3% the stock paid just less than a month ago when I purchased shares, it is still considerably higher than the stock's median dividend yield of 1.18% during the past decade. BAC only closed 3% of trading days in the last 10 years with a dividend yield higher than 2.56%, all of which were in the past couple of months.

Source: mad-dividends.com

This last year, the dividend grew 20%, which is slightly lower than their 5-year CAGR of 29%.

This rate of dividend growth is obviously not sustainable in the long run and should be considered a ramp-up dividend growth rate.

Source: mad-dividends.com

After four quarters at $0.18, investors are looking to BAC to see if they will keep this new streak of dividend increases alive. I personally believe they will, as a show of strength, but that investors shouldn't expect much more than a token increase of 1 cent per share this year. However, I expect BAC to resume 10-15% dividend growth in subsequent years, thus resuming its ramp-up.

Over the previous 3 years, Bank of America has seen its revenues grow at a 2% CAGR and net income by a 6% CAGR. The last decade has been a challenge, and the bank's revenues and earnings were finally going in the right direction during the past 5 years, before COVID-19 hit.

Source: mad-dividends.com

The growth in net income translates to a higher net income per share because of BAC's generous commitment to buybacks in the past two years, reducing the share count by 15%.

Below 2.5%, I wouldn't be interested in BAC, because I don't believe they will average 20% dividend growth over the next 5 years. I do believe they will average between 10% and 15% however, and this level of growth would still be suitable with the current yield.

Dividend Summary

The combination of the data presented above gives BAC a dividend strength score of 93/100. The dividend is invariably extremely safe, and management has shown commitment to growing its dividend.

However, BAC's dividend streak is still quite new, and management's commitment to dividend growth will truly come through in the next dividend announcement. While my expectations are just for a minimal $0.01 increase per share, management could show a show of strength by increasing by $0.02, thus increasing the dividend by 11%, while many stocks are cutting dividends.

BAC is still attractive to dividend investors at current prices, yet if you wait too long, you might miss the boat.

Stock Strength

BAC still is a good buy for dividend investors. But what of its likelihood to outperform the market in upcoming quarters? I'll turn to our factor analysis, analyzing both BAC's value and momentum.

I'll omit the quality analysis, as our quality score's meaning is close to irrelevant on banks. Many of the standardized ratios we use to calculate the quality score wouldn't be used in assessing a bank's stability and quality. As such, BAC scores awfully at 14/100. To put this in perspective, Citibank (C) scores 11/100 and WFC scores 8/100. This is due to differences in the structure of a bank's balance sheet.

Value

• BAC has a P/E of 11x
• P/S of 2.68x
• P/CFO of 3.71x
• Dividend yield of 2.56%
• Buyback yield of 9.33%
• Shareholder yield of 11.89%.

These values would suggest that BAC is more undervalued than 93% of stocks, which is very encouraging. However, it should be noted that the forward buyback yield will likely be 0% as BAC has suspended its buyback program, as have most companies. Its PE is in line with that of its sector, as is its dividend yield and price to sales. Its price to cash flow is exceptionally low, however. Compared to BAC's 10-year median PE, the stock is still very fairly valued.

Source: mad-dividends.com

While trading just below its median PE for the 10-year period, BAC seems to still offer considerable value. Buybacks have been suspended, as they should in these times of uncertainty, but I'm quite sure they will resume within a year or two, to supplement explosive dividend growth. BAC still appears around 10% undervalued.

Value Score: 93/100

Momentum

Bank of America's price has increased 4.97% these last 3 months, despite being down -15.05% these last 6 months and just about flat these last 12 months and, now, currently, sits at $28.11.

Source: mad-dividends.com

BAC has better momentum than 57% of stocks, which I find to be encouraging. The challenge will come in upcoming weeks as the 200-day SMA comes within striking range of the stock price. I see some likely resistance at the $30 mark, yet a crossing of the 20-day SMA and 50-day SMA could be a breakout event for BAC, catapulting it back up above $30 per share. I see such an event as about 30% likely, with the most likely outcome being the price bounces off $30 and trades between $26 and $30 for a while.

Momentum score: 57/100

Stock Strength Summary

When combining the different factors of the stock's profile, we get a stock strength score of 77/100, which is very encouraging. The low quality score is compensated by the usually higher value scores which banks command. The momentum indicates that BAC is turning around despite still being 18% lower than its high point. A show of strength in the next dividend announcement in July would go a long way to position BAC as the superior bank to hold throughout all markets and could fuel further capital appreciation.

Conclusion

With a dividend strength score of 93 and a stock strength of 77, Bank of America is a good choice for dividend investors, provided that they can purchase the stock when it yields 2.5% or more. Above 3%, it was a bargain, but who knows when such an opportunity might come again?

If you were unable to load up during the past months, now might be the last chance you get before this ship sails.

Liked this article and want more such dividend analysis? Then click on the orange "follow" button at the top of this page so that we can let you know when we next publish an article on Seeking Alpha

Analyst’s Disclosure: I am/we are long BAC, VFC. 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.