Why Bank of America Could Be the Dow's Biggest Winner in 2012

It's no secret that last year was brutal for banking. None of America's biggest banks left 2011 unscathed:

Source: S&P Capital IQ.

While Wells and JPMorgan managed to avoid meltdowns because of perceived quality, the rest were battered as investors feared what lurked in Wall Street operations. It's no coincidence that Wells is closest to a pure retail bank and it was the closest to breaking even.

Compare these returns to the Dow's (INDEX: ^DJI) 5.5% gain, and it's no surprise that Bank of America led the Dow's losers. JPMorgan, the only other bank in the Dow 30, was the fourth worst.

What's amazing to me is that I thought the banking sector, coming off its financial-crisis beatdown, was really cheap at the beginning of the year. In fact, back in November of 2010, the first two stocks I picked in the banking-centric real-money portfolio I run for the Motley Fool were Bank of America and JPMorgan.

Since that point in November, those two picks are down 42% and 3%. Take a look at the amazingly low price-to-book ratios of the biggest banks now.

Wells may look high in comparison, but remember that it usually (justifiably) trades for premiums. It wasn't unusual to see Wells trading at 2 to 3 times book value in the past.

On the low end, Bank of America trades at just a third of book value. In the decade before the financial crisis, Bank of America never once traded at even book value.

So, bottom line, banking is certainly troubled. And critics will say that these are multiples on "supposed book value" because not even the best analyst really knows what all lurks on big banking's balance sheets. But if the book values the banks are reporting have even half the quality of what they claim, we could see the banking sector's shares recover impressively.

Bank of America is already leading the Dow's gainers in 2012, up almost 20% (off a very low base). We'll get more data when it reports fourth-quarter earnings on Jan. 19. That particular report may or may not be favorable, but don't be surprised if Bank of America goes from worst to first on the Dow this year. (Post-publication note: Bank of America basically met expectations when it reported. Due to strategic asset sales, it is now profitable on a trailing-12-month basis. Overall, I liked what I saw and I'm still bullish on Bank of America.)

I believe the banking sector as a whole is being undervalued because of uncertainty. But there is serious and unknowable risk in the biggest players. If Bank of America's opaque balance sheet isn't your cup of tea, let me point you to a smaller, simpler bank that has some of the best operational numbers I've ever seen. I wrote about it in our brand new free report: "The Stocks Only the Smartest Investors Are Buying." I invite you to take a free copy to find out the name of the bank I believe Warren Buffett would be interested in if he could still invest in small banks. Get access now.