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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.
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).
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 (NASDAQ: 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.
Or am I dead wrong?
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