For the past eight years, Bank of America's (NYSE: BAC) stock has traded for a discount to the bank's book value per share, qualifying it as a bargain in many investors' minds. But that's no longer the case.
After climbing more than 45% since the presidential election, shares of Bank of America finally eclipsed the $24 mark earlier this month, which means its stock now trades for a 3% premium to book value.
Not to belabor the point, but this is the first time since the financial crisis that the nation's second biggest bank by assets hasn't traded for below its book value. That's an important threshold that current and prospective investors in the $2.2 trillion bank should take note of.
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There's no question that Bank of America's stock could still go higher, as more profitable banks tend to trade for 30% or more over book value. However, it's equally important to recognize that there's a limit to how much higher shares of the North Carolina-based bank can go given the fundamentals.
This all boils down to the relationship between a bank's profitability, which is measured by return on equity, and the valuation of its stock. The higher a bank's return on equity, the higher its valuation.
As a general rule, a bank's shares will trade for a premium to book value only if the bank is creating value for shareholders in excess of similar investment alternatives. The demarcation point for banks is their cost of capital. So long as a bank's return on equity exceeds its cost of capital, in other words, its shares should trade for a premium to book value.
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The issue with Bank of America is that it isn't earning its cost of capital -- which, according to my math, equates to an 11.7% return on equity. Bank of America had a very good 2016, but its return on tangible common equity was only 9.54%.
Bank of America's performance last year was better than 2015, when its return on tangible common equity came out to 9.08%. And it's much better than 2014, when the figure was a mere 2.52%.
Bank of America's stock just crossed a major hurdle, trading for the first time since the financial crisis at a premium to the bank's book value. Image source: Getty Images.
Why Are Bank Of America's Shares Still So Cheap?
The bank still has a lot of ground to make up before its profitability exceeds its cost of capital. Higher interest rates and the current presidential administration's vow to deregulate the financial services industry will certainly help. But those things will take time to filter through to Bank of America's bottom line.
In sum, there's a reason bank investors responded the way they did in the wake of the presidential election, but that response has ensured that Bank of America's shares are no longer cheap.
I am by no means arguing you should sell its shares. However, I am saying that you shouldn't buy its stock today with the expectation that it'll go a lot higher in the foreseeable future.
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Bank Of America Corporation (bac) Stock Price, News, Quote & History
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Bank of America Corp.'s (BAC) stock has already dropped 17% from its highs. Nowtechnical analysissuggests the stock is on the cusp of falling 6% more. Should that happen, the stock will have entered into a bear market more than 20% off its highs.
Despite the steep drop the stock is trading at a very high valuation based on its price to tangible book value. This high valuation comesdespite significantly slowing earnings and revenue growth in 2019.
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The chart shows that the stock is failing to rise above technical resistance at $28. That suggests the stock may fall back to technicalsupportaround $26, declining from its current price around $27.40. The relative strengthindex has been steadily trending lower since peaking at overboughtlevels in January. It suggests that bullish momentum continues to leave the stock.
The stock's sharp drop has not helped the valuation much, with the shares trading a price to tangible book value of 1.57. That is still well above the historical range of 0.5 to 1.5 since 2010. The valuation would need to drop to around 1.2 to come back to the historical norm.
Another potential headwind is slowing earnings growth in 2019. Earnings growth is expected to slow 12% down from 40% in 2018. Additionally, the estimates for 2019 have fallen steadily since the summer. Revenue estimates for next year have also dropped to around 4% from 5%.
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The slowing growth and declining earnings estimates for 2019 may be one reason why the stock is currently trading with a 2019PE Ratioof 9.5. It may suggest investorsbelieve earnings estimates will continue to fall.
The stock, along with many banks, may continue to struggle should the U.S. yield curve continue to flatten. Meanwhile, slowing loan growth has also plagued this group in recent months. Should that trend continue, Bank of America and other bank stocks are likely to continue to struggle.
Michael Kramer is the Founder ofMott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-onlyThematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years.Click here for Kramer's bio and his portfolio'sholdings.
Is Bank Of America Stock A Buy?
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The SNL U.S. Bank and Thrift index lost 5.4% of its value during the month, relative to a negative 3.8% total return for the S&P 500. In the S&P Global Market Intelligence analysis, only three of the 50 largest banks by market capitalization at Sept. 30 — Cincinnati-based Fifth Third Bancorp; Birmingham, Ala.-based Regions Financial Corp.; and Memphis, Tenn.-based First Horizon National Corp. — experienced market gains.
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With a negative 15.7% total return in September, Citigroup Inc. was one of the worst market performers in the sector. The stock has traded below its adjusted tangible book value for the last eight months. As of Sept. 30, Citigroup was the 11th-cheapest bank in the analysis by price to adjusted tangible book value.
The other three banks in the Big 4 — JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. — limited their market percentage losses to single digits. JPMorgan and Bank of America consistently trade at a premium to the industry, while Wells Fargo has traded at a discount all year.
Four banks entered the bottom-25 valuation list in September: Citigroup; Coral Gables, Fla.-based Amerant Bancorp Inc.; Walnut Creek, Calif.-based BayCom Corp.; and Los Angeles-based Hope Bancorp Inc. All four banks had monthly returns of negative 10% or worse, with Amerant suffering the worst market performance among banks in the analysis.
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Both Amerant and Hope Bancorp have substantial commercial retail exposure. As of June 30, Amerant had 19.2% of its gross loans in the commercial real estate retail category, while Hope Bancorp had 17.7% of its gross loans in retail buildings.
Exiting the bottom-25 list were Westfield, Mass.-based Western New
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