Bank of America Corp Remains Cheap, and I’m Buying More Warrants

The upside on B of A warrants is tremendous

May 21, 2014 at 10:26AM

Yes, I know Bank of America (NYSE:BAC) seems to have misplaced some billions in capital and that it had to scrap its dividend and buyback plan for the moment. But are you investing for next week or for how the bank will perform in the coming years? If you're looking to the future, then Bank of America is cheap – really cheap. So my Special Situations portfolio is back to buy another slug of Bank of America's A warrants (NYSE: BAC-WTA).

I explained why I liked the A warrants in my original buy recommendation early April. From my original purchase price of $7.94 per stub, the warrants are down now to $6.77, as B of A's common stock got hit in the wake of the accounting adjustment.

So the price decline offers an even better value for long-term investors. Even Warren Buffett remains upbeat about the company, as expressed in his shareholders' meeting in Omaha. Strikingly, B of A's stock price remains well below the valuation metric Buffett uses to determine a fair buying price. Buffet's buying heuristic is a stock trading at less than 10 times earnings before taxes. And obviously that includes room for profit, so anything with an endurable franchise that is cheaper than 10 times must be quite cheap indeed.

So how cheap is Bank of America common stock on this metric? If you include the recent $9.9 billion in legal settlements, then the company had $13.5 billion in earnings before taxes. At the current market cap of $154 billion, that works out to an 11.4 multiple.

But those legal issues won't surround B of A forever, so we really need to look at the core franchise. And that is doing quite well. Revenue is up 7% year over year, and provisions for loan loss are down 62%. So excluding those legal settlements, adjusted earnings before taxes come in at $23.4 billion – 73% higher than before. So the core banking franchise is trading at a bargain basement 6.6 times EBT.

Foolish bottom line
So let's disregard the noise of the bank's abortive capital return plan for the moment and see how cheap this bank really is. I'm looking to juice the upside by buying the A warrants, and will purchase $500 of those later this week. I expect at least 20% annual returns here. I'm continuing to find high return ideas as part of my Special Situations portfolio and will have more new money-making ideas out later this week, so follow me on Twitter (@TMFRoyal).

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Interested in Bank of America, or have another stock to share? Check out my discussion board or follow me on Twitter, @TMFRoyal.

Jim Royal has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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