3 Reasons Bank of America Corp's Stock Could Fall

The idea that Bank of America's (NYSE: BAC  ) stock could fall is certainly out of sync with the megabank's recent progress. But there are nevertheless multiple threats on the horizon. What follows are three of the most imminent.

1. Stocks prices are high right now

As I see it, the biggest threat to Bank of America's stock price has little to do with the bank itself. It stems instead from the simple fact that stocks appear to be expensive right now -- both in nominal terms and on a price-to-earnings basis.

If you've seen a chart of the S&P 500 recently, then you know what I'm talking about. Since bottoming out in 2009, the large-cap index has soared to all-time highs. At present, it's flirting with the 2,000-point threshold, which is more than 30% higher than the past two market peaks during the heights of the technology and housing bubbles.

Beyond nominal stock prices, moreover, the current valuation of the market also suggests that stocks are too dearly priced. Since 1900, the S&P 500's price-to-earnings ratio has averaged 16.5, according to data compiled by Yale professor Robert Shiller. By comparison, the most recent figure is 25.7.

2. Another surprise legal settlement

While it appears that Bank of America's latest multibillion-dollar settlement is likely to be its last, analysts and commentators (me included) have been wrong on this count before -- click here for a complete list of Bank of America's legal judgments and settlements since 2008.

Earlier this month, the nation's second largest bank by assets reached an agreement with the U.S. Justice Department and several federal and state agencies that clears up investigations into the bank's -- or, more specifically, Countrywide Financial's -- sale of faulty residential mortgage-backed securities in the lead-up to the financial crisis.

The deal calls for Bank of America to pay $9.65 billion in cash and provide approximately $7 billion worth of consumer relief, consisting of mortgage modifications, low- to moderate-income mortgage originations, and "community reinvestment and neighborhood stabilization efforts."

By my count, this leaves Bank of America with only one major unsettled case, a $2.5 billion dispute with mortgage bond insurer Ambac Financial, which has probably already been reserved for and thus moved through Bank of America's income statement.

The elation in the market was evident when the bank's latest deal was announced on Aug. 21. Since then, its share price has increased by almost 6%. If previously unexpected cases materialize, in turn, it wouldn't be unreasonable to presume that the news would trigger a similarly sized pullback.

3. Bank of America's earnings could disappoint

Make no mistake about it: Bank of America is a turnaround story. If it doesn't continue to move in the right direction, in turn, then investors would be excused for expecting the market to respond in kind.

More specifically, Bank of America must address its efficiency ratio, which measures the percentage of revenue consumed by operating expenses.

As you can see, the bank's efficiency ratio is currently 84.3%, meaning that less than 16% of its top-line revenue is available to pay taxes, boost book value, or return to shareholders via dividends or share buybacks. By contrast, an ideal ratio for a lender like Bank of America is in the neighborhood of 60% -- and exceptional operations such as US Bancorp's are closer to 50%.

To be clear, with the exception of its legacy legal issues, this has been Bank of America's biggest priority over the last few years. It's sold off numerous non-core businesses, reduced its branch count, and cut payroll. But for investors to be satisfied, progress must continue to be forthcoming.

The bottom line on Bank of America's stock

There's no doubt that Bank of America is a different company today from what it was five years ago. And there's also no doubt that it's become a better business thanks to the changes it's made in this time frame.

But for the bank's stock to continue ascending, Bank of America can't let off the gas pedal just yet. Most importantly, it must fully and finally extinguish all legal liabilities stemming from the crisis as well as address its industry-lagging efficiency ratio before it can claim any semblance of victory.

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  • Report this Comment On August 26, 2014, at 2:19 PM, djtetsu wrote:

    #1 isn't a reason at all, how about comparing with other banks? "Because the market is hot, a stock could fall" ... doesn't enlighten anyone.

    Their last legal settlement had investors jumping for joy and buying. "Because the stock is hot, the stock could fall" ... doesn't enlighten anyone.

    #3, so there is room for improvement, that is good, earnings can improve and so can stock price.

  • Report this Comment On August 26, 2014, at 10:41 PM, hjpatel wrote:

    Bank of America is undervalued. Patient Long-term investors will do well. $20's here we come.

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John Maxfield

John is The Motley Fool's senior banking specialist. If you're interested in banking and/or finance, you should follow him on Twitter.

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