Why Bank of America Soared to New Heights

The last few years have been trying times for investors in Bank of America (NYSE: BAC  ) . After shares of the nation's second-largest bank dipped below $10 in July of last year, many analysts couldn't fathom a further descent. I, for one, bought in around that time and was certain of an impending, if not immediate, rebound. Much to my chagrin, shares ultimately fell another 50%, plummeting to under $5 almost exactly one year ago today.

It's for this reason that many of you are probably feeling increasingly vindicated. Over the past year, shares of the bank have more than doubled and are now on the verge of breaking the $11 threshold -- a 52-week high. This performance has made it the best performing component on the Dow Jones Industrial Average (DJINDICES: ^DJI  ) in 2012 by far. The runner up, Home Depot (NYSE: HD  ) , trailed by a staggering 40 percentage points. And it's also dramatically outperformed the other too-big-to-fail banks such as JPMorgan Chase (NYSE: JPM  ) , Citigroup (NYSE: C  ) , and Wells Fargo (NYSE: WFC  ) .

BAC Chart

BAC data by YCharts.

I've discussed on multiple occasions why B of A has done so well this year. As a result, I'm not going to rehash those explanations here. If you want to dig further into this, read any or all of the following three articles:

  1. 3 Reasons Bank of America Soared in 2012
  2. It's Time to Buy Bank of America
  3. Has Bank of America Turned the Corner?

I want to focus instead on what you should do now, as after such an impressive run, it's near-irresistibly tempting to take your money and run. Here's why doing so is a mistake.

Despite doubling over the past year, B of A's shares still trade at less than half of book value and almost 30% less than tangible book value. With a still-considerable quantity of toxic mortgages on its books and billions of dollars worth of outstanding legal liabilities related to the financial crisis (and its purchase of Countrywide Financial more specifically), there's no reason to think that this valuation will improve overnight to, say, one times book.

At the same time, however, it will improve. One of the primary catalysts for such an improvement will be regulatory approval to increase its dividend. And as I've said before, I believe this will happen in the first half of next year once the Federal Reserve conducts its annual stress tests and reviews B of A's capital allocation plans.

Now, suffice it to say, I could be wrong. But I don't think I am -- talk about famous last words! The reason I'm confident is because B of A has begun to accumulate a comparatively large quantity of capital. Believe it or not, as my colleague Amanda Alix recently noted, it's now the best capitalized major money center bank with a Tier 1 capital ratio under Basel III of 8.97% -- Citigroup's is 8.6%, JPMorgan's is 8.4%, and Wells Fargo's is 8.02%.

With this in mind, the real payoff to an investment in B of A will come gradually over time via dividend payouts. Follow me through some math here. Once the dust finally settles from the financial crisis, most analysts, both inside the company and outside of it, believe that B of A will earn upwards of $30 billion a year if not more -- Brian Moynihan himself, B of A's CEO, estimates the likely range at $35 billion to $40 billion once things normalize. That's roughly $3 per share. And assuming B of A ends up distributing a third of that, which is a conservative estimate, that equates to an annual dividend of $1. At the current price, that's a nearly 10% yield, and under this scenario, the underlying shares themselves could very realistically increase twofold if not more.

In other words, I believe the best days are still ahead for shareholders of B of A.

Don't take my word for it
'm very aware that I could be accused of talking my own book, as I own shares of B of A. However, I'm not the only one at the Motley Fool who thinks the same way. In our new, in-depth report on B of A, our senior banking analyst Anand Chokkavelu explains why he believes its shares could "double or triple over the next five years." To learn why Anand thinks this, download the free report by clicking here now.

Read/Post Comments (2) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 17, 2012, at 4:24 PM, Hestheone wrote:

    Gee...a $10 stock goes to $5 and then back to $10 because of government intervention in the industry and somehow that is astounding performance? If the Fed were buying out any other businesses bad loans I would expect their value to go back up as well.

  • Report this Comment On December 20, 2012, at 12:59 PM, larrysd1 wrote:

    Maybe Motley needs to back there standing and bump BAC to 4 stars.Thanks

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