The financial sector has been one of the hardest-hit parts of the stock market since the COVID-19 pandemic sent the stock market plunging into a bear market earlier this year. And Bank of America (NYSE:BAC) has been especially disappointing. Even after the recent rebound, the bank has lost more than one-fourth of its market value in 2020.
With that in mind, here's a quick overview of just how cheap Bank of America has become, why the stock has done so poorly, and why it might be a good bank stock to buy now.
Bank of America is trading for a significant discount
After the stock market's sharp rebound since hitting its lows in March, the S&P 500 index is just 4% lower than where it started 2020. Meanwhile, the financial sector has been slow to recover -- still down by approximately 20% year to date.
Bank of America has performed even worse, still down by 27% for the year. The stock now trades for 7% less than its book value, a historically low valuation. For context, Bank of America has traded at a premium of 5% to 25% for much of the past couple years.
The business is doing quite well
To be sure, there are some legitimate reasons for the underperformance. For one thing, Bank of America set aside $3.6 billion in the first quarter to cover anticipated loan losses, but there's quite a bit of uncertainty as to whether that will be enough -- especially if the economic effects of the COVID-19 pandemic end up being far worse than expected. Just to name a few potential trouble spots:
- Bank of America had $94.5 billion in credit card loans outstanding in the first quarter. Credit card loans are one of the most recession-sensitive types, and default rates can spike into the double-digit percentage realm in tough economies.
- The bank has $16.4 billion in loans to the beaten-down energy industry and a total of $36.3 billion in committed funds that could be drawn.
- Commercial real estate loans make up more than $70 billion of the bank's loan portfolio. Retail adds another $25.9 billion and consumer service-based businesses make up $28.4 billion.
So, if the recession gets especially bad or lasts for a long time, Bank of America's losses could certainly spike. And it's that uncertainty that's holding the stock price down.
The business is doing quite well
While there's still quite a bit of uncertainty in the near future, it's important to point out that Bank of America's business has being performing quite well. Excluding an impairment charge, Bank of America produced a return on equity (ROE) of 11.3% and a return on assets (ROA) of 1.21% in 2019, both of which represent tremendous improvement in profitability over the past few years. And thanks to investment in technology and generally smart expense management, Bank of America's efficiency ratio has consistently been among the best in its peer group in recent years.
Plus, the bank has returned more than $95 billion to shareholders in the form of dividends and share repurchases since 2013, and the outstanding share count has dropped by more than 20%.
Finally, the bank's investment banking operation should help cushion the blow of the pandemic. Certain aspects of investment banking tend to do better in turbulent markets -- for example, trading revenue was up by 22% in the first quarter.
In short, Bank of America is a well-run institution with a diverse revenue stream that has improved dramatically in the years since the financial crisis.
It's a good value, but is it the best bank stock?
Bank of America is trading at a nice discount and its business is doing well. But is it the best bank stock?
Well, it depends on your definition of "best." Bank of America isn't trading for quite as steep of a discount to book value as Citigroup (NYSE:C) or Wells Fargo (NYSE:WFC). And it doesn't have quite as impressive of a track record of profitability as JPMorgan Chase (NYSE:JPM), nor is it as efficient as U.S. Bancorp (NYSE:USB) has been in recent years. But it is a solid combination of a great business at an attractive price, which makes it a very attractive bank stock for long-term investors.