One of the reasons bank stocks have surged since the presidential election is that investors expect the current administration to follow through on Trump's campaign vow to lower the top corporate tax rate from 35% to as low as 15%. But while all banks would benefit from this, as would all other profitable companies, few would gain as much as Bank of America (NYSE:BAC).
The nation's second-biggest bank by assets paid $7.3 billion in income taxes last year. Only five companies on the S&P 500 paid more than that, with two of those also happening to be banks -- JPMorgan Chase and Wells Fargo.
Why do banks pay so much in taxes compared to other companies? The simple answer is that they earn more money. Apple is the only company in the country that earns more than JPMorgan Chase. Wells Fargo and Bank of America aren't far behind. Their net incomes over the past 12 months rank them fourth and sixth on the S&P 500, respectively.
Unlike most other leading blue-chip companies, banks use an enormous amount of leverage, typically holding $10 worth of assets for every $1 in shareholders' equity. This allows banks to scale up their profits relative to other types of companies. Every $1 in shareholders' equity at Apple, for instance, translates into a comparatively modest $2.50 worth of assets.
Cutting the top tax rate on corporations from 35% down to 15% would therefore be a boon for Bank of America. It would have reduced the North Carolina-based bank's tax liability in 2016 by nearly half, or 48%, leaving $3.5 billion in additional net income to hit the bank's bottom line. That would make a huge difference, boosting Bank of America's net income by 19%, or approximately $0.35 per share.
The challenge for investors right now, however, is that much of this already appears to be priced into Bank of America's stock. This explains why its shares are up 44% since the beginning of November. To put that in perspective, the S&P 500 is up only 13% over the same stretch, while the KBW Bank Index has climbed 24% -- the latter tracks two dozen large-cap bank stocks, including Bank of America, JPMorgan Chase, and Wells Fargo.
If Trump's tax plans don't come to fruition -- and that could very well be the case, given the impact of the cuts on the federal deficit -- bank stocks could be in for a correction. It's too early to say if that will happen, but investors in bank stocks should keep it in the back of their minds.
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