Bank of America (NYSE:BAC) has sold off hard for the past quarter. The stock is down 22% for the quarter and 18% year to date. This has created a substantial buying opportunity for savvy investors I’d say. It appears an initial breakout is underway. The stock looks technically solid here. Take a look the chart below.
The stock bounced off support and is now consolidating prior to the next leg higher, I surmise. Look, all the greatest long-term investors say pretty much the same thing when it comes to buying opportunities, only in differing terminology. Warren Buffett has the most famous buying opportunity quote:
"Be fearful when others are greedy and greedy when other are fearful."
You get the idea. Our innate instincts encourage us to depart a sinking ship. This survival tactic impacts the way we invest. Often, investors sell out at the exact time they should be doubling down. An unjustified selloff based on macro factors often creates opportunities to buy stock in solid companies with sound prospects. I submit this is the case we have with Bank of America. The stock presents an excellent dividend growth and total return opportunity at present. Let me explain.
Excellent dividend growth and total return opportunity
The primary thesis behind this pick is the dividend growth opportunity coupled with the potential for substantial capital gains. I have been pounding the table on the stock for the last decade. I wrote an article in January of 2012 titled "The Time Is Now To Buy Bank Of America" when the stock was trading for $6.84. I’m up 527% over the last 10 years.
With 440% coming from capital appreciation and the balance from dividend payouts.
So, I'm up substantially on this name in my dividend growth portfolio, but feel the stock has much more room to run. I see another great decade ahead for the stock. The primary catalyst for the stock over the next decade will be prospects for continued substantial dividend growth. Moreover, a major positive paradigm shift has occurred for the banking sector, or as Shakespeare would say, the worm has turned.
Federal Reserve Paradigm Shift
A massive paradigm shift has occurred. A fundamental change in approach to regulations by Washington coupled with the Fed's newly minted hawkish stance has created the perfect environment for Bank of America to flourish. On top of this, legal woes for the bank are now clearly in the past. The market backdrop for banks has turned notably positive due to the following factors.
Rising interest rates - Banks make more money on loans in rising interest rate environments. The NII (Net Interest Income) should increase substantially as the rates rise. Bank of America Q1 earnings topped consensus estimates as net interest income rose and loan and deposit growth continued. Chief Financial Officer Alastair Borthwick stated:
"Net interest income increased by $1.4B versus the year-ago quarter supported by strong loan and deposit growth. Going forward, and with the forward curve expectation of rising interest rates, we anticipate realizing more of the benefit of our deposit franchise.”
Increased volatility - The trading arm of banks tend to be more profitable during times of market volatility.
Regulatory reform - Banks are the most highly regulated of the sectors. The recent regulatory reforms should help the banks greatly in the coming years. I see this as the tip of the iceberg. Nevertheless, the primary catalyst for the stock is the dividend growth story. Let’s take a look.
Dividend growth analysis
Bank of America has done an exceptional job growing the dividend over the past decade.
The dividend current stands at $0.84 annually and $0.21 per quarter with a current yield of 2.32%.
The dividend growth metrics all have high scores according to Seeking Alpha’s dividend growth scorecard over all timeframe for the past 10 years.
I have no doubt Bank of America will continue the progress in this area. Furthermore, the bank is currently trading at a very attractive valuation. Let's review.
Bank of America is on sale. The bank is current trading at half the market P/E at 9.23.
What’s more, the bank is trading for 1.21 times book value with a PEG ratio of 0.67, half of its primary competitor JP Morgan (JPM).
The PEG ratio is a widely accepted indicator of a stock's prospective value. It is favored by many analysts over the price/earnings ratio for the reason that it also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued. A PEG of 1 or less is believed to be promising. As Warren Buffett would say, "Price is what you pay, value is what you get." Furthermore, the stock is still trading for less than two times tangible book value which is the historical average for the bank. Now for the bottom line.
The Bottom Line
The banks have begun to break out in the past two weeks. I submit the Fed 50 basis point rate raise Wednesday will mark the beginning of a rally for Bank of America.
The combination of regulatory reform, a rising rate environment, accelerating loan growth, and the fintech revolution lowering costs should allow Bank of America to substantially increase the dividend over the next decade. I posit this will, in turn, drive the stock higher creating substantial total return opportunity. My 12-month price target is $49, implying a 32% capital gain coupled with continued dividend growth. Those are my thoughts on the matter. I look forward to reading yours.