- Bank of America stock has delivered very high returns over the past 5 years.
- The current stock price is slightly above the Wall Street consensus 12-month price target.
- The option-implied outlook for BAC is moderately bearish.
- The stock has a lot of good news priced in.
- My final overall rating is neutral.
Bank of America (NYSE:BAC) stock has gained 173% in five years, with annualized total return 23.95% per year. Contrast this to Citigroup’s (C) 12.61% per year over the same period. The question for investors, of course, is whether the stock price has gotten too far ahead of implied earnings so that the stock is overvalued. Citigroup has a forward P/E of 10.6 and a yield of 2.9%, as compared to BAC’s 15.2 forward P/E and 1.95% yield. I recently analyzed Citigroup so I wanted to go through the same process for BAC.
Price chart and basic stats for BAC (Source: Seeking Alpha)
Over the past 3-, 5-, and 10-year periods, BAC’s price returns have far exceeded its sector, Diversified Banks. On one hand, this is a great vote of confidence in expected future earnings. On the other hand, it means that more projected success is priced in.
Trailing returns for BAC vs. Diversified Bank sector and U.S. equity market (Source: Morningstar)
Wall Street Analyst Outlook
While the consensus opinion of the 15 ranked analysts surveyed by eTrade is bullish, the current stock price is higher than the 12-month consensus price target. The stock price already reflects much, if not all, of the expectations that resulted in the analysts’ bullish view.
Wall Street analyst consensus rating and 12-month price target for BAC (Source: eTrade)
The consensus calculated by Seeking Alpha, using a group of 27 Wall Street analysts, is almost identical to the price target calculated by eTrade. It is notable that there is only one bearish analyst and one who is very bearish from among this group of 27.
Wall Street analyst consensus and price target for BAC (Source: Seeking Alpha)
Outlook from the Options Market
Another way to generate an outlook for a stock is to analyze the prices at which options on the stock are trading. The market prices of options provide information about traders’ consensus outlook on the probability of the price going above a certain level (call options) or below a certain level (put options) over some period of time (from today until the expiration date of the options). By aggregating market prices of call and put options with the same expiration date but different payouts (different strike prices), it is possible to employ a mathematical model to calculate the implied probability of all possible future returns. This strategy is well-established in institutional finance. For some background, see the Minneapolis Fed’s web pages on their implementation. For a review of the literature on how options prices are useful in generating outlooks in general and with examples using my version of this approach, see this presentation.
The option-implied probabilities of expected price returns are charted as a probability distribution. When I chart the option-implied probability distribution for future return, I rotate the negative side of the distribution about the vertical axis so that the relative probabilities of positive and negative returns are easier to see.
The price outlooks derived from options prices are probabilistic rather than a specific forecast of the future price. The options prices may indicate increased or decreased likelihood of gains or losses and this provides insight into the prevailing beliefs of those buying and selling options.
I have analyzed options expiring on January 21, 2022, to generate an option-implied price return outlook from now until that date.
Option-implied price return probabilities for BAC from now until January 21, 2022 (Source: Author’s calculations using option prices from eTrade)
The outlook derived from the options prices is moderately bearish, with the single most-probable price return of -11.5% between now and January 21, 2022. Also bearish, the probability of negative returns is consistently higher than the probability of positive returns of the same magnitude for returns (red dashed line is above the blue solid line) in the range +/- 40% (from 0% to 40% on the horizontal axis of the chart above). The annualized volatility derived from this distribution is 35%. The probability of having a price return less than or equal to zero over the period from now until January 21, 2022, is 55% (45% chance of a positive price return). The median price return is -3.9% over this period.
This option-implied outlook is similar to what I got when I recently analyzed options on Citigroup. That analysis showed a most-probable price return of -10% and annualized volatility of 37%. The estimated probability of negative price returns was 56% (44% chance of positive price return)
The option-implied price return outlook for BAC is moderately bearish. The current stock price is above the Wall Street analysts’ consensus price target. In addition, the current valuation is not terribly attractive as compared to other banks. With a forward P/E of about 15 and a yield of about 2%, BAC does not look cheap. Seeking Alpha’s quantitative value grade for BAC is D+ as compared to B for Citigroup, for example. The Wall Street analysts’ consensus rating for BAC is bullish, however, with very few analysts rating BAC less than neutral. My final overall rating is neutral, balancing the analysts’ bullish view, the option market’s moderately bearish view, and the relatively high valuation.
This article was written by
Analyst’s Disclosure: I am/we are long C. 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.
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