Whenever you're looking at a company's stock to invest in, one of the first questions you should ask yourself is: How does the company make money?
Asking this will help to hone your sense for whether the company at issue has a sustainable business model; it'll also help get your mind around the types of things that will cause the company's revenue to increase or decrease in any given quarter.
With this in mind, I opened Bank of America's (NYSE:BAC) 2015 10-K to see how its revenue broke down by source last year. All told, as you can see in the chart at the top of this article, the nation's second biggest bank by assets generates revenue in eight principle ways:
- Net interest income: Earned by borrowing money from depositors and other wholesale fund providers and then investing that money in higher-yielding interest-earning assets.
- Asset management and brokerage fees: Earned principally by Bank of America's Merrill Lynch and U.S. Trust subsidiaries, which manage customer assets, such as individual retirement accounts, and generate revenue from transaction fees in brokerage accounts.
- Service charges: These consist of fees on deposit accounts, such as account fees, overdraft fees, nonsufficient funds fees, etc.
- Trading: Earned in Bank of America's investment bank principally by making markets for clients that are institutional investors -- i.e., hedge funds, pension funds, and insurance companies, among others.
- Card income: Earned from credit card related charges, including interchange income (a.k.a. "swipe" fees), account fees, late fees, and so on.
- Investment banking: Fees earned from taking companies public, issuing debt securities for clients, and advising on mergers and acquisitions.
- Mortgage banking: Just as it sounds, this is related to the origination, servicing, and sale of mortgages and home equity loans.
- Investment gains: Earned when Bank of America sells an asset/investment for more than it bought it for.
Speaking very generally, there are two things to point out here. First, a large plurality of Bank of America's revenue comes from its portfolio of interest-earning assets. This is why interest rates are the single most important variable that play into Bank of America's profitability -- higher rates equate to higher profits.
And second, each of these categories is subject to its own unique set of levers. For instance, Bank of America's asset management and brokerage fees stem principally from the value of its assets under management as well as from the volume of client stock trades. Meanwhile, its card income is driven by the number of outstanding credit card accounts (this drives annual fees) combined with purchasing volume (which drives interchange income).
In sum, there's a lot of moving pieces here, but for the astute investor with time on their hands, breaking down Bank of America's revenue streams like this, and then analyzing each of the component parts, can go a long way toward helping you determine whether the bank's stock is a viable long-term investment.