If your new to investing, you want to approach a stock like Bank of America's carefully. Image source: iStock/Thinkstock.
A lot of people own Bank of America's (BAC +0.78%) stock -- it is, after all, the most heavily traded stock on the S&P 500. But shares of the nation's second biggest bank by assets aren't well suited for everyone, including beginning investors.
B of A's appeal to beginning investors
The draw of Bank of America's stock is easy to understand. Most people in the United States have heard of the North Carolina-based bank. This goes along with author and investor Peter Lynch's advice to invest in what you know.
Because Bank of America's shares are so heavily traded, moreover, investors needn't worry about buying into it and not being able to later sell their stock if and whenever they want to do so. The same can't be said for smaller, riskier stocks, which don't offer the same degree of liquidity.
Data source: YCharts.com. Chart by author.
Despite the public's anger toward banks, fueled by recent revelations of a massive fraud at Wells Fargo, these companies provide a critical function in the economy -- allocating capital between savers and spenders -- and aren't about to go away anytime soon. This is particularly true with the too-big-to-fail banks -- thus the name.
Reasons to think twice about B of A
Despite all of this, beginning investors should nevertheless think twice before taking the plunge and buying Bank of America's stock.
In the first case, Bank of America is an incredibly complicated company. I've studied and written about it more than all but a small handful of people over the past five years, and there are still many more things that I don't know about it than the things I do know. I'd go so far as to say that the vast majority of its own employees are in the same boat.
What makes it so complicated is the fact that it provides all of the services of a traditional bank, an investment bank, and a wealth manager. These activities are subject to different, and often conflicting, cycles that cause the returns in each of the divisions to march to the beat of their own drums. For instance, while higher interest rates will be great for Bank of America's lending activities, it will hurt the value of its investment securities and could reduce revenue from its Wall Street operations.
Additionally, Bank of America's shares are especially volatile. It has a beta of 1.7, meaning its shares are 70% more volatile on any given day than the broader market. By comparison, the average beta among large-cap bank stocks (i.e., members of the KBW Bank Index) is 1.21 -- that's 21% more volatile than the broader market, but nearly 50 percentage points less volatile than Bank of America.
This is important because stocks that fluctuate wildly can cause investors to buy high and sell low. You buy when its shares are soaring, making you greedy. And you sell after its shares take a hit, making you fearful. Studies have shown that this is the typical investor's standard operating procedure.
So, should beginners buy B of A?
I'm bullish on Bank of America. It's one of my and my wife's largest stock holdings. My thesis is that its valuation and profitability, both of which were impaired during the financial crisis, will eventually recover.
It's a long-term hold, in other words, and one that doesn't promise to be smooth sailing. If you can stomach the volatility, then it's worth a look. But if you can't, or you don't know how you'd react if its shares lost half their value, which could very well happen, then you should look elsewhere.
