1 Reason to Own Bank of America's Stock

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Whether or not you're talking about Bank of America  (NYSE: BAC  ) , the single best reason to buy stock in a company is probably this: You think the company is worth more than where the market values its stock.

It's as simple as that.

It's up for debate whether Bank of America is really worth more than the $149 billion that the market currently says it's worth. But as a Bank of America shareholder myself, I'm confident that the answer is a resounding "yes."

You can attempt to reach this conclusion (or refute it) a number of different ways. Today, I'm going to go about it by smashing Bank of America into a whole bunch of little pieces. That is, I'm going to determine a value for each of Bank of America's individual business units and then add that all up to get an idea of what the entire bank is worth.

For readers that enjoy learning wonky jargon, I'm going to use a "comps-based" approach for this. That means that I'm going to grab each of Bank of America's business units, find similar, non-Bank of America companies, look at how they're valued, and apply that valuation to the Bank of America unit.

Let's get started.

Core banking
Bank of America has three businesses that are involved in relatively basic banking: consumer and business banking (CBB), consumer real estate services (CRES), and global banking (GB).

CBB and GB are both really good banking businesses. Try not to look so surprised. CBB earned a near-21% return on its allocated equity through the first nine months of the year. GB managed an even better 21.5% return. While CBB's credit-quality metrics don't look top-of-the-heap quite yet, they have been improving nicely. GB, on the other hand, currently has credit metrics that are... well, let's just say much better than you'd expect from Bank of America.

What we'd ideally want to do now is find other banks earning 20%-plus on their equity and see how they're valued. The problem with that is that there just aren't large, stand-alone banks that have returns on equity that are that high. Among the bigger banks, US Bancorp  (NYSE: USB  ) and Wells Fargo  (NYSE: WFC  ) get the closest with respective ROEs of 13.9% and 13.4%. Among smaller banks, First Republic Bank  (NYSE: FRC  ) and SVB Financial  (NASDAQ: SIVB  ) have delivered solid (though distinctly sub-20%) returns as well. 

The median tangible book value multiple of the group above is 2.3. If we apply that to Bank of America's CBB and GB, we get a combined $122 billion (go ahead and write that down).

Before we move on, remember I left out the CRES business thus far. This is a tricky one because CRES has been a particularly lackluster business. It also includes most of what was once Countrywide Financial -- which, at this point, is a four-letter word for most Bank of America shareholders. Plus, the division has been on the receiving end of a lot of Bank of America's big legal settlements.

On the flip side, this is a business that has a significant nationwide presence in the mortgage banking market and has produced $6 billion in year-to-date revenue. I hardly think it's completely worthless. But to be conservative, I'm only willing to value this unit at half of its equity. That's the kind of valuation that the worst-hit banks were getting in the midst of the crisis. That multiple would put a $12 billion value on CRES (you can write that down, too).

That icky investment banking
Prior to the financial crisis, Bank of America already had an investment banking arm. It was probably best described as a "pretty OK" investment bank. Then, when the bank decided to overpay for the sick and dying Merrill Lynch, it acquired a world-class investment bank -- at least, based on the parts that didn't sink Merrill.

Some of Bank of America's investment banking operations are included in GB, so we've already accounted for them. However, the rest of it -- which includes most of the trading operations -- is stashed under the heading global markets (GM). 

Through the first nine months of this year, GM has produced $1.3 billion in net income. That'd be roughly $1.7 billion on an annualized basis. Bank of America's GM division is no Goldman Sachs  (NYSE: GS  ) , but Goldman would be the closest comparable for us to consider. Goldman currently trades at roughly 10 times its trailing earnings. With that in mind, I'd consider it fair to value Bank of America's GM at eight times earnings, or about $14 billion (go ahead, mark that down).

Asset management
Remember what I said about Bank of America getting some good investment banking operations when it picked up Merrill Lynch? Well, that goes double for the brokerage and assets management businesses that it acquired. 

At the end of the third quarter, Bank of America's Global Wealth and Investment Management (or GWIM, pronounced "gee-whim" -- go ahead and say it, it's fun) reported $780 billion in assets under management (AUM) and more than $1 trillion in brokerage assets.

This time around I determined, on average, how assets managers -- like BlackRock  (NYSE: BLK  ) and T. Rowe Price  (NASDAQ: TROW  ) -- are valued based on their AUM, as well as how brokers -- like TD Ameritrade  (NYSE: AMTD  ) and LPL Financial  (NASDAQ: LPLA  ) -- are valued based on their brokerage assets. 

After calculating and applying those to Bank of America's GWIM, I get a value for that business of a little more than $36 billion (mark it!).

If anything, this undervalues GWIM -- maybe significantly -- because it ignores certain parts of the business and uses some comparables that don't have as much profit-generation potential. Valuing GWIM at $36 billion would give it a price-to-earnings ratio of 12.4 based on the annualized profit it's produced so far this year.

And... everything else

Bank of America rounds out its business groupings with a final catch-all called, creatively, "other." Other doesn't make much money. Other does, however, have a lot of the bank's equity stashed in it. Other also includes a variety of investments valued at more than $2 billion.

I'm not willing to assign much value to other. Part of the reason is that other doesn't make much money, so it's hard to think of the unit as particularly valuable. I also believe a lot of the bank's equity that's stashed in other is necessary to maintain regulatory capital ratios while the banking and markets businesses chug along on a thinner capital base. That means that the bank has to keep that equity less encumbered and can't earn a lot on it.

At the risk of vastly undershooting, I valued other at just the stated value of its investments, so $2.1 billion (yup, go ahead and write that down).

If you've been following along

You now should have a list of the values for Bank of America's component businesses that looks something like this:

  • Consumer and Business Banking and Global Banking: $122 billion
  • Consumer Real Estate Services: $12 billion
  • Global Markets: $14 billion
  • Global Wealth and Investment Management: $36 billion
  • Other: $2.1 billion

Add that all up and you get a grand total of $186.1 billion. That's a full 25% above where the market currently values Bank of America. Note that this doesn't mean that -- if my numbers are right -- the return potential on Bank of America's stock is 25%. What it means is that Bank of America's would be fully valued once it appreciates 25%. So investors have the potential to collect the stock's market-related returns plus the 25% it would take for the stock to reach full valuation. Alternatively, it could mean that I'm wrong by a pretty wide margin and still bank a solid return (Ben Graham and Warren Buffett would call this my "margin of safety").

And, for the sake of argument, I'd posit that if this workup errs on one side, it would be on the side of undervaluing Bank of America. Between the low valuation applied to CRES, the conservative approach to GWIM, and the next-to-nothing value on the stash in Other, I'd say the bank is more likely than not worth more than what I've come up with here.

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Read/Post Comments (17) | Recommend This Article (19)

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 November 07, 2013, at 11:22 PM, imyasaswy wrote:

    I remember reading an article titled "Bank of America - Inside America's most hated bank" on the Motley Fool by John Reeves. And this article went on to explain why it is a bad idea to invest in BOA.

    Now, after reading this article, I am very confused. As a rookie investor I am baffled at the lack of consensus here. While I understand that there will be different perspectives on every stock recommendation, such extreme views from the same team of experts is overwhelming.

  • Report this Comment On November 08, 2013, at 7:13 AM, larrysd1 wrote:

    Thanks for the great info and article

  • Report this Comment On November 08, 2013, at 8:55 AM, broknrekord3 wrote:

    @Imyasaswy

    That's exactly what's important about the Fool... it isn't a one-sided argument that 'these are the best stocks to buy and we all agree so we can't ever be wrong'; much like everything else, there are multiple ways to critique businesses and their future successes. If it were easy, everyone would be doing it and be millionaires.

    As for me, I bought BAC many moons ago and I'm expecting the payoff within 4-5 years. Having worked in real estate law for a number of years, the reality is that BAC is still one of the most entrenched banks in the real estate market, nevermind the other stuff it does, and simply isn't going away. Compiled with a low market value, it's a steal.

    To you, it might not be a great buy, and that's fine. But at least you'll be informed from both sides of the argument before you make a decision, which is the only way to make a Foolish decision.

  • Report this Comment On November 08, 2013, at 9:17 AM, TMFBane wrote:

    @imyasaswy,

    Sorry for the confusion. I can completely understand the dilemma of having to weigh two completely different assessments.

    The simple answer is that John Maxfield, Ilan Moscovitz, and I disagree with Matt on Bank of America. He’s laid out his case above, and we’ve laid out ours in the previous column that you mention.

    I’ll let Matt’s article speak for itself, but will share my view here briefly. I completely understand Matt’s argument that Bank of America has a solid business and that it appears undervalued using the traditional techniques favored by analysts. That view is quite commonly held by many analysts here as well.

    John Maxfield, Ilan, and I approached this investing idea somewhat differently, however. We were struck by the company’s truly horrendous reputation, and all of the lawsuits, settlements, etc. Now some might view the settlements from a valuation perspective – hey, they have more than enough money to cover it all. That’s, of course, a perfectly reasonable way to approach that.

    But we saw that as very troubling. Does this indicate a problem with the business model?

    So that was our starting point. Is there a problem with the business model and the culture? As a result of our analysis, we believe there is.

    Speaking for myself – I think that might have a negative impact on the bank over the long term. I approach investing as a “business owner” and prefer to invest in companies that I feel happy to align myself with. Matt says the best reason to buy a stock is “you think the company is worth more than where the market values the stock.” I couldn’t disagree more! But it’s a healthy disagreement. I have great respect for Matt. We just view the world differently. That probably explains why we view this one so differently too.

    Foolish best,

    John Reeves

  • Report this Comment On November 08, 2013, at 12:49 PM, TMFKopp wrote:

    @Imyasaswy

    brokrekord3 and John already nailed it, but yes, the idea is that there isn't one "correct" answer on something like this. So rather than pretend that there is, at The Fool we share our motley (get it? :) ) views, even (and maybe especially) when they're at odds. We'd rather our readers hear all sides -- the warts along with the beauty -- as opposed to just getting one canned party line.

    Thanks for reading and Fool on!

    Matt

  • Report this Comment On November 08, 2013, at 1:00 PM, TMFKopp wrote:

    Also, I should probably just quickly note on John's comment:

    "I approach investing as a “business owner” and prefer to invest in companies that I feel happy to align myself with. Matt says the best reason to buy a stock is “you think the company is worth more than where the market values the stock.” I couldn’t disagree more!"

    Just to clarify here, I also invest with a mind towards being a business owner. As such, the idea that "you think the company is worth more than where the market values the stock" isn't simply a blind look at the most recent numbers -- it's a comprehensive view on all aspects of the business and how those myriad factors play into how profitable the company can be and, by extension, what it's worth.

    I imagine John was mainly reacting to the idea that investing is about more than just numbers on a page (he's right, it is!!!). But at the end of the day, once you've taken all those factors into account, good investing -- whether you consider yourself an investor chasing value, growth, income, or whatever -- is all about paying less for an asset (read: company) than what it's actually worth.

    Matt

  • Report this Comment On November 08, 2013, at 2:04 PM, wouter28 wrote:

    "The simple answer is that John Maxfield, Ilan Moscovitz, and I disagree with Matt on Bank of America."

    Isn't John Maxfield a BAC shareholder?

  • Report this Comment On November 08, 2013, at 5:24 PM, Rusty56 wrote:

    Wouter - Yes he claims to be so his taking part in slamming the bank makes absolutely no sense. That's why I take many of these foolish 20 yr. olds with a grain of salt, although Matt is starting to grow on me. I bet if Maxfield owns BAC, it's all but 10 shares.

  • Report this Comment On November 09, 2013, at 12:23 PM, funfundvierzig wrote:

    1 Reason to Never Own Bilk of America (BAC):

    ENRON ETHICS! The bank's long endemic culture of ENRON ETHICS and dirty tricks is hostile to shareholders, hostile to investors, hostile to customers, hostile to regulators, and hostile to regular bank employees.

    ENRON ETHICS does not build but destroys shareholder value.

    Merely the individual opinion of one retail investor…funfun..

  • Report this Comment On November 09, 2013, at 1:07 PM, imyasaswy wrote:

    Appreciate all the comments and the great articles. Getting into the grove now. :)

  • Report this Comment On November 09, 2013, at 1:45 PM, heidi115 wrote:

    i am getting a lot recs. for boa & wells fargo, than i get one that says bricks & morter banks dead. i should jump on intrenet banks. don,t what to do with all this give and take

  • Report this Comment On November 09, 2013, at 1:49 PM, Firecaptain9 wrote:

    Why was nothing mentioned about Countrywide?

    BOA was practically forced into taking it over by our incompetant Government officials who in turn then sued BAC for what Countrywide did. Many suits have been settled, but I do not feel it is over.

    BAC was smart enough to keep Countrywide seperate, what they should have done is have Countrywide declar bankrupsy instead of continually bailing them out at BOA's expense.

    having said that, I do jump in and out of BOA, jumped back in @ $13.80 and will be out around $14.50.

  • Report this Comment On November 09, 2013, at 3:07 PM, xetn wrote:

    I think BAC is overvalued because of the method of accounting for all their real estate loans that the underlying collateral does not have to be (nor is it) valued at market.

  • Report this Comment On November 10, 2013, at 10:15 AM, secretgreg wrote:

    Does anyone talk to each other in this company? What the hell am I paying for if two people say two different things???? John Reeves needs to speak with the guy next to him Matt Koppenheffer.

    Sounds to me that this company has no direction when making stories. Maybe they should get together like TMZ before they start talking crap.

  • Report this Comment On November 16, 2013, at 11:51 AM, Stroh wrote:

    "secretgreg", dunno about you but I am paying for information and I unserstand that information will be presented based on the presenter's opinion.

    We all know about opinions.... two different people = two different opinions. It is in my best interest to use all information (especially opposing views) in my investing decision.

    Like "funfundvierzig" I choose not to invest in BAC because of the kind of company it seems to me to be, but that's just me.

    If everybody always agreed, no one would make any money in the stock market.

  • Report this Comment On November 16, 2013, at 9:05 PM, TomHW wrote:

    Does anyone know if BAC is making a sincere effort to clean up its behavior. If so, shouldn't those who are squemish about the company's morals feel good enought to let the numbers cited above lead them to invest?

  • Report this Comment On November 18, 2013, at 4:46 PM, CaddyKen wrote:

    I think that, when it comes right down to it, each individual has to decide what is 'right' for them.

    Personally, I have to agree with those that feel that BAC's reputation is deservedly poor and so it is not simply a matter of will they make money for shareholders- I am pretty sure that they will. Of course, there is a (immeasurable?) level of risk embedded in an investment in a company with pervasively poor ethics. Enron is certainly a reminder.

    I just think that there are a lot of alternatives out there that are more attractive and I can let this one pass.

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