Why Bank of America (BAC) Should Head Higher

Bank of America Corp (NYSE: BAC)

Admit it: even you don’t like to see your stocks fall. No matter how much you brace yourself for the volatility of the markets, you still feel that pang of regret when you see your picks drop in price. It’s inevitable. It’s human nature.

Now, put that feeling away because we are going to take a look at a stock that has been falling steadily over the past few months. Since the start of 2016, Bank of America is down an astonishing 27%. This has been driven in large part by fears over loans written to oil companies on the bank’s books.

Bank of America has disclosed that it could potentially lose around $700 million from its oil portfolio of loans this year if the price per barrel of oil stays around $30 through 2016. To put this in perspective, Bank of America today runs an $903 billion loan portfolio, of which $21 billion is comprised of loans to the energy sector as of the end of the fourth quarter of 2015.

The stock price of Bank of America is hovering around $12 per share. This is a stock price that was last seen in 2010 when the bank was losing – that’s right, losing – around $2.2 billion per year. Contrast to today, Bank of America made $15.9 billion in profits in 2015. What gives?

The depressed valuation of the stock is being driven by a negative bias to the financial sector due to the lingering memory of the financial crisis and investor agitation towards the current $0.20 annual dividend payment. Why is the dividend payment so low? During the financial crisis, the dividend got slashed from an annual $2.56 dividend payout to a $0.04 annual payout. Because Bank of America suffered heavy losses and massive litigation costs coming out of the financial crisis, it suffered low and erratic net profits for years.

It lost $2.2 billion in 2010. It made $1.4 billion net income in 2011. It made $4.2 billion net income in 2012. Then it made $11.4 billion net income in 2013, with many people thinking that the tide had finally turned for the bank. However, in 2014, profits shrunk to $4.8 billion net income as the final round of legal settlement costs were expensed. Now, the profits are finally clear of all the heavy costs incurred during the financial crisis and profits closed out at $15.9 billion in 2015.

However, Bank of America is currently retaining $14 billion and only paying out $2 billion in dividends, thus the investing community’s hostility towards the low dividend payout. However, this is the wrong way to approach the dividend payout. With the legacy costs of the financial crisis largely behind them, Bank of America is back to being a regular, large US bank. Profit forecasts for 2016 are in the $18 billion range. The dividend payout will eventually expand as the profits shed its erratic behavior and grow in a consistent manner going forward.

The current low stock price of Bank of America makes little sense. It’s only being valued at around 9 times trailing twelve month earnings. Tangible book value is at $15.62 per share. Standard book value is at $22.54 per share. Depending on how conservative you want to be, the stock price represents a discount of somewhere between 20% to almost 50% of book value. That represents some margin of safety built into the low stock price. Even if some of the loans in the energy portfolio go south due to prolonged low oil prices, book value per share shouldn’t, in all probability, go anywhere below $12 per share.

Bank of America has finally shed almost all of its baggage from the financial crisis, both in terms of the costs and profitability hit it took from 2008 to 2009. Profits are finally hitting their stride. Whenever interest rates revert back to the mean, profits will go higher as the bank can charge more for its loans. With increasing and steady profits, dividend hikes should be coming down the line. At a stock price of around $12 per share, Bank of America is truly at an unusual, and attractive, price.

Disclosure: This author has no positions in any stocks mentioned and does not plan to open any positions in any stocks mentioned for at least 72 hours after publication of this article.

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