Despite worsening losses on bad loans, the future is bright for Bank of America
In the short term, the bank will continue to be hurt by bad loans. Yet that short-term pain should be mitigated by strong investment banking results: The purchase of Merrill Lynch means Bank of America should enjoy some of the same prosperity as Goldman Sachs
Bank of America's earnings should improve even before bad loans peak. I'm making an educated guess that during 2010, management will reduce its provision for those loans, expecting improvement in the rate. The reduced amount will fall to the bottom line. As the environment returns to normal over the next couple years, look for Bank of America's earnings per share to move toward my "normalized" projection of $3.00, versus the $2.18 analysts expect for 2011.
Management changes are another positive. With CEO Ken Lewis stepping down this year, investors should benefit. Lewis and his predecessor inflicted so many overpriced acquisitions on shareholders that if they picked the next CEO at random from the Charlotte, N.C., phone book, it would likely be an upgrade.
Though often lumped in with troubled Citigroup
Bank of America's P/E multiple is higher than normal, but bear in mind that next year's earnings should be the cyclical bottom as loan losses peak. The stock is only trading at around six times "normalized" earnings of $3 per share.
With earnings so depressed, tangible book value may be a better measure of valuation, and it is more bullish. Bank of America currently trades at just 141% of tangible book value; that is more than one-third lower than one year ago, when the stock traded at 228% of tangible book value.
Another positive: As earnings bounce back, Bank of America should raise its dividend from $0.01 to something closer to 40% of earnings. If "normal" earnings are around $3 per share, then that suggests a dividend of around $1.20 per year, offering support to the stock while providing nice current income.
For investors who can stomach some bumps along the way, Bank of America looks like a good long-term value play.
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