Buy The Decline In Bank of America

Summary

• BAC is 24% below the 12-month high from early 2022.
• Rising interest rates are favorable for this stock.
• The Wall Street consensus outlook is bullish, with a 12-month price target that is 30% above the current share price.
• The market-implied outlook (calculated from options prices) is bullish.
• Selling covered calls can provide high income.

ablokhin/iStock Editorial via Getty Images

Bank of America (NYSE:BAC) has fallen almost 8% over the past 12 months and 24% since the 12-month high closing price on February 8, 2022. The precipitous decline is even more notable given that BAC has beaten expectations on EPS for the past 8 quarters, most recently on April 28th for Q1. In addition, rising interest rates tend to be good for bank earnings because higher rates mean higher interest income on variable rate loans.

Seeking Alpha

12-Month price history and basic stats for BAC (Source: Seeking Alpha)

Over the past 3 months, BAC has returned a total of -22.5% vs. -18.7% for the diversified bank industry group (as defined by Morningstar) and -9.1% for the S&P 500 (SPY). The Invesco KBW Bank ETF (KBWB) has returned a total of -19.2% over the same period. Banks have sold off more than the broader U.S. equity market and BAC has declined more than the industry. This is somewhat hard to understand. The Fed has been unequivocally clear on the plan to gradually raise interest rates to combat the multi-decade high inflation. One factor that has added to confusion is the slight inversion of the yield curve in March, which has historically served as a strong predictor in impending recession. The market appears to be struggling to reconcile surging inflation on the one hand and the recent yield curve inversion on the other.

ETrade

Trailing and estimated future quarterly EPS for BAC. Green (red) values are amounts by which EPS beat (missed) the consensus expected value (Source: E-Trade)

The consensus EPS growth rate for the next 3 to 5 years is 7.5% per year. The trailing 3-year dividend growth rate is 12.4% per year. With the low payout ratio, 23.1%, BAC can maintain a dividend growth rate that exceeds the EPS growth for some period of time. Using the trailing dividend growth rate for expected dividend growth, the Gordon Growth Model indicates expected total return of 14.7%.

I last wrote about BAC on March 9, 2021, at which time I assigned a neutral / hold rating. At that time, BAC was trading at a forward P/E of 15.2, on the high end of historical levels and the share price was slightly above the consensus 12-month price target. Even though the Wall Street consensus rating was bullish, the shares looked sufficiently expensive that there was little or no expected upside.

Seeking Alpha

My previous analysis on BAC and subsequent performance vs. the S&P 500 (Source: Seeking Alpha)

In addition to looking at fundamentals and the Wall Street consensus rating and price target, I rely on the market-implied outlook, which reflects the consensus view from the options market. The market-implied outlook in early March of 2021 was bearish.

Considering the bullish Wall Street consensus rating, the high valuation, and the bearish market-implied outlook, I compromised on a neutral rating for BAC. Since this article was posted, BAC has returned a total of 4.1%, about ½ the return for the S&P 500 over the same period.

For readers who are unfamiliar with the market-implied outlook, a brief explanation is needed. The price of an option on a stock reflects the market’s estimate of the probability that the stock price will rise above (call option) or fall below (put option) a specific level (the option strike price) between now and when the option expires. By analyzing the prices of put and call options at a range of strike prices, it is possible to construct a probabilistic price forecast that reconciles the options prices. This is the market-implied outlook and represents the consensus view among buyers and sellers of options. For more background than is provided here and in the previous link, I recommend this excellent monograph published by the CFA Institute.

I have calculated an updated market-implied outlook for BAC and I compare this with the current Wall Street consensus outlook in revisiting my rating on BAC.

Wall Street Consensus Outlook for BAC

ETrade calculates the Wall Street consensus outlook for BAC by aggregating the views of 13 ranked analysts who have published ratings and 12-month price targets over the past 3 months. The consensus rating bullish and the consensus 12-month price target is 29.5% above the current share price. Even the lowest price target is 12.7% above the current level. It is notable that the 12-month consensus price target is very close to the 12-month high closing price of $49.4.

ETrade

Wall Street analyst consensus rating and 12-month price target for BAC (Source: E-Trade)

Seeking Alpha calculates the Wall Street consensus outlook based on ratings and 12-month price targets from 26 analysts who have published opinions over the past 90 days. The consensus rating is bullish and the consensus 12-month price target is 31.5% above the current share price.

Seeking Alpha

Wall Street analyst consensus rating and 12-month price target for BAC (Source: Seeking Alpha)

These two versions of the Wall Street consensus agree very closely, with a bullish rating and expected 12-month total return (adding the dividend) of 32.8%. The prevailing view among the analysts implies that the recent decline in BAC is unwarranted.

Market-Implied Outlook for BAC

I have calculated the market-implied outlook for BAC for the 8.6-month period from now until January 20, 2023, using the prices of options that expire on this date. I selected this specific expiration date to provide a view through the end of 2022 and because the January expiration date is especially actively traded.

The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.

Geoff Considine

Market-implied price return probabilities for BAC for the 8.6-month period from now until January 20, 2023 (Source: Author’s calculations using options quotes from E-Trade)

The market-implied outlook for BAC to early 2023 has a significant tilt in probabilities that favors positive returns for the period. The maximum probability corresponds to a price return of 6%. The expected volatility calculated from this outlook is 35%. For comparison, E-Trade calculates implied volatility of 37% for the options expiring on January 20, 2023.

To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).

Geoff Considine

Market-implied price return probabilities for BAC for the 8.6-month period from now until January 20, 2023. The negative return side of the distribution has been rotated about the vertical axis (Source: Author’s calculations using options quotes from E-Trade)

This view shows that the probabilities of positive returns are consistently higher than the probabilities of negative returns of the same magnitude, across a wide range of the most-probable outcomes (the solid blue line is above the dashed red line over the left ⅔ of the chart above). This is a bullish market-implied outlook.

Theory suggests that the market-implied outlook will tend to have a negative bias because investors, in aggregate, are expected to be risk averse and thus to overpay for downside protection (put options). There is no way to measure whether this bias exists, but the expectation that probabilities of negative returns will tend to be overestimated further reinforces the bullish interpretation of the market-implied outlook for BAC.

Income-oriented investors or those seeking to limit risk exposure may want to consider selling covered calls against BAC holdings. Today, I bought shares of BAC for $36.66 and sold January 20, 2023 call options with a strike price of $37 for $3.95. The option premium provides income of 10.8% over the next 8.6 months. This position is expected to provide $0.42 in dividends over this period, for a total income of 11.9% (which translates to 16.6% in annualized income). I chose to sell essentially all of the potential upside on this position (by selecting the option strike price so close to the current stock price) because I have purchased BAC as part of the income-focused allocation in my portfolio.

Summary

BAC has sold off as the broader equity market has fallen and also, I hypothesize, because investors are confused by the lack of clarity from having high inflation along with a fairly flat and (sometimes) an inverted yield curve. I cannot identify any bad news that explains the disproportionate decline in BAC relative to other major banks. The Wall Street consensus outlook on BAC is bullish, with a 12-month consensus price target that implies a total return of 32.8%. As a rule of thumb for a buy rating, I want to see an expected 12-month total return that is at least ½ the expected volatility (35%-37%, in this case). BAC substantially exceeds this threshold, taking the Wall street consensus price target at face value. The market-implied outlook for BAC is also bullish to early 2023. I am changing my rating on BAC from neutral / hold to bullish / buy.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BAC either through stock ownership, options, or other derivatives. 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.

I have sold covered calls against my long position in BAC

Comments

[mag1205]

BAC has fallen from it's high of $50 plus down to $36 plus some change. BAC won't recover to $50 this year in my opinion. Fundamentals are still in place but jittery markets and negative consensus are two factors which won't go away soon.

I have been long BAC since 2008 and staying optimistic.

[Adasstadnicki]

hi best regards from Poland
if specialists advisors says to buy banks in time of crisis, it is not normal, looking for sheep only

right now we have to wait, the stock market is risk off for the moment

price is cheap but it will be much more cheaper then right now

wait for second or third bottom, maybe October?

I wish you good luck, stocks are normally right now only a hazard game ...

[Adasstadnicki]

Thanks a lot
So minus Look on the market It is going down
Read the zerohedge article about bofa manager who said that market will go down
Look no the managers They are selling the stocks from all banks right gs ms citi bofa
It is not time to buy banks
Wait for October
Dont look on opinion of the analysts They will always tell you to buy banks but it will fall down You will see
There is to mych inflation To big pressure for sale of stocks Lot of people are on cash right now and waits

Remember do exactly opposit to opinion of analysts

Best regards from Poland Adam Stadnicki Orlenik

[grharbart201]

Best article in quite some time IMO. I will follow you on Monday.

[optional-]

BAC has now run 90% of its course. It can't grow much and it has become woke and stupid giving your money to BLM and other rip-off marxists.

For banks with real growth opportunities and better valuations (at the moment) look at AX and INBK. These are online-only banks that don't ever pay for heat, tellers, property taxes, or skyscrapers in Atlanta. AX has been growing profits at 15%+ for the last decade (even made a profit in 2008 an 2009). Take a peak. You will be shocked at how much better the financials and prospects are for these banks than for the dying woke monstrosity that is BAC.

[seagulljonathan]

More general question. In this recession environment, how will big banks be doing well? What about main street regional banks?

[Old Professor]

My most recent purchase was at $13 share.

BofA has been a roller-coaster or boom-and-bust stock for the four or five decades that I have followed it. It's good to buy during the almost inevitable "busts," and to sell during the almost inevitable "booms."

[Jlexus1953]

Interest rate hikes and buybacks will have a positive impact moving forward

[SleepyInSeattle]

BAC: still too high - HOLD

[thedudeman]

peer here is former cfo & cio of large bank. he was buying the banks in the summer of 2020 when no one wanted them - he’s buying them again this last week.

[User 12154021]

You’re calls are going to get exercised and lose out on a lot of upside over 8.5 months. I’d recommend going shorter term on covered calls.

[KimBEAV]

@User 12154021 I agree. The strike price is set far too low.

[Geoff Considine]

@User 12154021 I think that you are probably correct. As I noted, however, my personal position with the covered calls sold on BAC is part of a slice of my portfolio that focuses on conservative (e.g. lower risk) income positions.

[User 12154021]

@Geoff Considine I'd probably debate with you are taking on more risk for the yield your attempting to get by sacrificing total return; sell weekly calls instead; you'll get similar returns with more control and more upside. you could also buy the US I-Bonds that yield 9.6%.