I really don’t want to sound like a broken record, so forgive me for putting this as bluntly as possible: Bank of America (BAC) is on sale, once again. At what point will YOU see it as a bargain?
If I were to show you the following chart, without naming the stock, what would you think?
I don’t know about you, but I would think to myself that since there are not that many bargains these days in the market, this one looks like a “no-brainer” to AT LEAST consider strongly buying shares of. I have to believe that just about anyone would agree with me. If not, perhaps I am looking at investing in a really odd way.
OK, now consider that BAC makes money by borrowing at the Fed “Discount Window” at rates that are about 1.75% and then lends that money at rates mostly well above 3.50%, and even higher for folks with low credit scores. To me this is like printing money. The bank does nothing but borrow low and lend high.
At the same time, millions of folks have checking and savings accounts with BAC and they MIGHT get an interest rate on their money of .65-1.00% unless you’re “special”. The bank turns around and lends YOUR money out at much higher interest rates to qualified borrowers. Are you still with me?
Now, these transactions take place every day, 24 hours per day, 7 days per week, 365 days per year. The only way the bank will LOSE money is if they lend unsecured funds, such as a credit card, but at interest rates that are over 20% most of the time. The risk is mitigated by the outrageously high interest charged. BAC will take that risk.
On the secured loans, there is either a house or a car, or an asset of some kind that allows BAC to cover most of their losses in the event a secured loan (like a mortgage) goes bad. These days, all banks, including BAC, have to meet certain requirements to keep cash available without touching it. Most banks now have enough in reserve to satisfy this requirement, and to have cash on hand in the event of a catastrophic financial problem, as we have seen so often in the past.
Are you still with me?
OK, so they have cash in reserve and money in checking and savings accounts that they pay paltry interest on, plus they have the “discount window” to borrow a whole lot of money. Then they lend the money to qualified borrowers or businesses. BAC sells nothing, manufactures nothing, and in reality offers one service, which is to keep your money safe with the help of the FDIC, which will guarantee your money up to a certain amount. Of course there are plenty of loopholes for individuals to have LOTS of money insured by the FDIC, but I am willing to bet everyone reading this knows what they are.
Now on top of the cash machine previously stated above, the bank also charges “fees”:
- ATM fees.
- Minimum balance fees.
- Regular checking account fees for those who maintain a low average monthly balance.
- Fees (like closing costs) just to actually lend mortgage money.
- Fees on some loans if you decide to pay the loan off before a certain time frame.
- Fees on their investment banking side, which has been getting stronger.
You could probably name a few more obvious ones that I am missing, but the entire business is all about making money on nothing but your money, or the Federal Reserve’s money. Are they printing money? Of course not, but it is as close to printing money without actually doing it that I can conceive of.
BAC never has to develop the next cell phone, or electric engine, or anything at all. It is not a cyclical business, and as long as BAC is solvent, they can do all of the above transactions all of the time.
Now It’s Time To Look At The Basics Again
I have shown one chart that for me says it all, but not quite everything. The following facts should be duly noted:
- BAC has a price to book value of just 1.10 right now. Historically, BAC price to book is about 1.75 roughly.
- The enterprise value is about $350 billion, while the market cap is about $280 billion.
- BAC has a forward growth rate for the next 3-5 years of roughly 11% annually.
- BAC has a 5-year average PE ratio of about 14.50, with a current ratio of about 15.20.
- BAC has free cash flow of about $9 billion and a cash flow growth rate of about 32% annually over the last 5 years.
- BAC’s gross margins are about 82%.
OK, so I think the picture is becoming more clear, right? Let’s take a look at the recent share price activity:
In just one week, the share price has dropped almost 5%. While I believe it was undervalued before this dip, I now believe that its stock is a total bargain, based on the fundamentals noted, and the way BAC makes money.
Not to mention that over the long term, interest rates will rise, and BAC will make more profits. As a matter of fact, the reason that I see for this dip is only because the Fed did not raise rates this time around. To me it stands to reason that when the Fed raises rates, the traders who have jumped off of the band wagon will jump ON the bandwagon once again, which should make the share price go back up. After that, in January when BAC announces earnings, it is more than likely to report another great quarter, as many analysts are “banking” on:
Dividend Growth Investing For The Future
I doubt if BAC will increase its dividend by 60% next quarter, but with the share price so favorable, and the yield just about 2% I would speculate that further dividend increases are coming. BAC has a very low payout ratio:
To me, this is like getting in on a ground floor opportunity at a cheap price. I believe this is what dividend growth is all about. BAC is now paying a dividend, has a low payout ratio, and in my mind could easily increase its dividends by 10-20% per year over the course of the next few years. I could be wrong, of course, but I am just adding up the facts that I know right now.
The Bottom Line
I believe that opportunity is knocking once again to buy shares of BAC. I added before, and I am adding again. There is no denying that the financial sector, specifically big banks, will lead the way for quite some time, and BAC offers a plenty of value all around.
Of course the choice is yours. While I understand that the current yield is lower than those who are already retired will accept, I cannot help seeing that the total return over the near, and longer term, is about as good as it gets for my risk level.
What do YOU have to say?
Not To Bore You, But…
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Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance. The long positions held are based upon what the model portfolio holds and I personally could have held all of the stocks noted at one time or another.
Disclosure: I am/we are long BAC.
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.