Bank of America's (BAC +0.94%) stock price has risen by about 150% over the past five years, so investors may think the stock looks a little too expensive right now. However, a big price move all by itself doesn't tell us much about any stock's future potential.
With that in mind, let's take a look at why Bank of America's stock has performed so well and if the future growth potential justifies the now-higher price tag.
Bank of America's emphasis on banking technology is paying off. Image source: Bank of America.
Bank of America's transformation and growth have been impressive
Since the financial crisis ended roughly a decade ago, Bank of America has done an excellent job of reducing its risk and responsibly building its business.
Bank of America's business has grown steadily and responsibly in terms of deposits, loans, brokerage assets, and most other areas of the bank's business. However, the change that I'm most excited about is the bank's emphasis on improving efficiency.
Over the past several years, Bank of America has invested heavily in building out its technology platforms, such as its mobile app, and has been strategically reducing its physical footprint by closing underperforming or unnecessary branches. In simple terms, it is much more cost-effective to have customers use digital banking services than to visit a branch. For example, when you factor in the cost of facilities, employees, paper, and other items, a mobile check deposit costs a bank roughly one-tenth of what a teller-processed deposit does.
The efforts have paid off. Bank of America's efficiency ratio has fallen (lower is better) from 69% at the end of 2015 to a far more respectable 60% today. In other words, the bank is spending $9 less for every $100 in revenue it generates than it did just a few years ago. At the scale of Bank of America's business, this makes a big difference.
And, thanks to a combination of the improving efficiency and the benefits of corporate tax reform, Bank of America has finally surpassed the industry profitability benchmarks of 10% return on equity and 1% return on assets. This would have seemed like a crazy thought in the wake of the financial crisis, and simply put, it's impressive at how effectively the bank has transformed itself.
Great results for shareholders
The bank's fantastic improvement is reflected in its stock performance. For 2017, the bank handily outperformed its peer group, with a total return of 35.7% versus 20.3% for the other big U.S. banks.
In addition, Bank of America is emphasizing its return of capital to shareholders. During 2017 alone, Bank of America bought back $11.9 billion worth of stock and paid $4 billion out as dividends. Given the bank's growth and profitability, I'd be surprised if both figures didn't get even higher in 2018 after the bank's capital plan is reviewed by the Federal Reserve.
Future catalysts
I already mentioned tax reform, and since the new 21% corporate tax rate is one of the few permanent tax changes, this should help keep Bank of America's profits elevated for the foreseeable future.
Another thing that could bump Bank of America's profits to the next level is rising interest rates. With a higher-than-average concentration on noninterest-bearing deposits, Bank of America stands to benefit more than most as interest rates rise. In fact, the bank's management has said that a 100-basis-point (1%) parallel shift in the interest rate yield curve could translate to an additional $3 billion in annual net interest income.
Additionally, the most powerful catalyst could be the continuous improvement of the U.S. economy. A strong job market with significant wage growth should translate to increased demand for loan and deposit products, investment accounts, and more, which could drive banking revenue much higher over the next few years.
Is it too expensive?
Bank of America has produced a 168% total return over the past five years, so it may seem like the stock has gotten a bit overheated. However, the bank's performance more than justifies the current stock price. In fact, based on first quarter earnings, Bank of America is trading for a P/E ratio of just 12.5, and the bank still trades for a significant price-to-book discount when compared with JPMorgan Chase, Morgan Stanley, and even scandal-plagued Wells Fargo.
In a nutshell, even though Bank of America has been one of the best performers in a hot financial sector, the stock still looks like a good buy now.
