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If you want to know how Bank of America (BAC +0.48%) will perform in the coming years, one place to begin your analysis is with the bank's own financial targets. Here are the three it references most often:
|
Financial Metric |
Bank of America's Target |
Where It's At Right Now (3Q16) |
|---|---|---|
|
Return on Tangible Common Equity |
12% |
10.28% |
|
Return on Assets |
1% |
0.90% |
|
Efficiency Ratio |
60% |
61.66% |
Data source: Bank of America.
1. Return on tangible common equity
The first target is the most important. Bank of America is striving to generate a 12% return on its tangible common equity.
Analysts and sophisticated investors tend to look at this metric more than any other to gauge how well a bank is performing. It's calculated by dividing a bank's annualized net income by its shareholders' equity (less intangible assets and preferred stock).
As a general rule, banks want to earn at least 10% on their tangible common equity, which is right around where Bank of America came in last quarter. It's a good sign, then, that the bank has set its goal above that.
2. Return on assets
The second target is similar to the first. Bank of America is striving to generate a 1% return on assets. This, like the first one, gauges profitability. But the difference is that the first one can be heavily influenced by leverage.
It's worth remembering that banks earn roughly half their revenue from leveraging up -- that is, by borrowing funds at low interest rates and then investing that money into assets (loans and government securities) that yield more. The greater the extent that a bank can do this, the more money it will earn (and the more risk it assumes).
If you want to measure a bank's profitability without leverage, then, the figure to use is return on assets. In this case, Bank of America has set its goal at a return on assets of 1%. That's in line with the standard industry benchmark and is slightly above how the bank performed in the third quarter of this year.
3. Efficiency ratio
Bank of America's final target is an efficiency ratio of 60%, which, once again, is in line with most banks' goals to come in at or below this mark.
As its name suggests, the efficiency ratio measures how efficient a bank is, comparing a bank's expenses to its revenue. It's calculated by dividing a bank's non-interest expenses by its net revenue, with a lower number being better.
Exceptionally well run banks such as U.S. Bancorp will often come in close to 50%, but there's nothing wrong with Bank of America's current target. At the very least, it means that the nation's second biggest bank by assets can't sit on its laurels, as its efficiency ratio in the latest quarter was 61.66%.
In sum, there's no saying for sure if Bank of America will reach these targets (though I'd be surprised if it didn't over the next couple years), but either way they shine a revealing light on what its executives are thinking in terms of their objectives.
