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Banking on Bank of America
12/25/2014 7:00 am EST
Our latest recommendation is the second-largest US bank, with 5,000 offices and total assets of nearly $2.2 trillion, notes Ian Wyatt editor of Million Dollar Portfolio.
Bank of America (BAC) is also the largest issuer of credit cards, through its acquisition of MBNA. And its 2008 acquisition of Merrill Lunch helped transform the bank into a leading securities firm.
In the wake of the financial crisis, BofA paid out an astounding $65 billion in fines, financial restitution, and legal fees. The latest was a $17 billion settlement related to its mortgage lending practices.
Those financial settlements have clouded the real financial performance of the business. Because the bank needs to write off these legal expenses, the real profits of the business have been depressed.
To invest in BofA, you need to think beyond the litigation. The good news is that BofA says that it has resolved 95% of the claims related to mortgage securities.
Looking forward to 2015, the uncertainty of these huge charges will disappear. When that happens, BofA profits should stabilize and grow considerably. In turn, investors should gradually embrace the stock.
Meanwhile, the stock has dramatically underperformed its US big bank peers and the S&P 500 index. The stock remains 68% below its all-time high.
Next year, Wall Street analysts expect the bank to turn a profit of $1.48 per share on revenues of $89 billion. That means that the stock trades at a forward P/E ratio of 12. Compared with the forward P/E of 17 for the S&P 500, that's pretty cheap.
Another common metric used to measure banks is called price-to-book value. BofA trades at 0.8 times book value. The market is saying that BofA's assets are worth 80 cents on the dollar, due to their level of risk.
Back in 2008, BofA's quarterly dividend reached $0.64. By 2009, that dividend had been cut to a tiny $0.01 per share. In September of this year, it was finally increased...to $0.05 per share and is well-positioned to continue rising in the years ahead.
Two or three years from now, big banks should trade in-line with the market as a whole. On that basis, I believe Bank of America stock will deserve a more normal and market-correct P/E multiple of 15.
On that basis, the stock could be worth $30 within the next three years. That translates to a 71% premium from the recent share price of $17.50.
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