A Look at Bank of America's Recent Quarter

In this episode of MarketFoolery, host Chris Hill is joined by Motley Fool senior advisor Jason Moser to discuss why Bank of America (BAC -0.13%) wrapped up the fiscal year with a mixed quarter. Also, Lumentum (LITE 0.12%) makes a $5.7 billion bid for rival laser company Coherent (COHR). Jason Moser analyzes those stories, plus they discuss Swedish live casino provider Evolution Gaming and the relative benefits of investing in the QQQE ETF.

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This video was recorded on Jan. 19, 2021.

Chris Hill: It's Tuesday, Jan. 19. Welcome to MarketFoolery. I'm Chris Hill. With me today, Jason Moser in the house. Good to see you.

Jason Moser: Hey, you.

Hill: We have an acquisition. It's not Monday, but it feels like Merger Monday. [laughs] We're going to dip into the Fool Mailbag. We're going to start with another big bank though because Bank of America wrapped up their fiscal year with, let's just call it, a mixed fourth-quarter report. Profits were higher than expected for Bank of America. Overall revenue was a little light, but the stock is flat, which is pretty much in keeping with the past 12 months for shares of Bank of America.

Moser: Yeah. The financial sector in general didn't have the greatest 2020, that was one of the under-performing sectors of the year, understandably. It's been a difficult environment for all sorts of banks, both big and small. But even looking through the release, [laughs] it's a bit of a trick to really square this one up, because in the release, one of the points the CFO said, "Despite one of the worst economic environments in modern memory," and you feel like right there, he's just setting us up for something. It's just not going to be very good. "We ended the year stronger than before the health crisis and well-positioned to support our clients," and they go on to talk about having grown deposits by $361 billion, capital ratios are at record levels. They're back to returning capital to shareholders. Given that it is one of the worst [laughs] economic environments in modern memory, these guys seem to be doing OK. That's great. Maybe there is something to the liquidity that's been pumped through the system here over the past year, and that's for obvious reasons.

I think going into the core, a lot of the things that I have been focused on, and we talked about this last week, but generally speaking, just how they are feeling about the recession, generally speaking, how they're feeling about returning capital to shareholders, if there was any perspective on the political climate and reserves, I think what was really another big point. Into that point, reserves are going in the right direction. I mean, they were able to release $828 million of reserves. We've talked before about releasing those reserves and put those reserves aside in order to prepare themselves for a potential difficult climate of write-offs and bad loans. Well, it's maybe not as bad as one suspected, so they're able to release that reserve and that goes to the bottom line.

Also benefiting earnings, they saw expenses decline $474 million from the previous quarter on lower litigation costs. They actually saw that net interest income bump a little bit, which was nice to see even though it's really incremental at best. But I think, all things considered, we saw a lot of similarities with the other big banks that announced on Friday. Deposits are up phenomenally. I mean, just going back to that liquidity with some pump through the system here over the past year, deposits were at 23%. Loans on the other hand, down a couple of percent. They're contending with a little bit of a difficult environment in that regard, but they do see a good environment for deposits here this coming year, and that's banks are in the business of making money with that money so that all to set them up for decent success here, this coming year, and then back to the returning of capital to shareholders. I mean, they're able to get back to buying back shares, keep paying the dividends. I think that ultimately puts these guys in a pretty good spot.

Hill: When you look at Bank of America flat over the past year, does it look like a value opportunity right here?

Moser: I definitely can see, yes. I think that generally speaking with these banks, I feel like 2021 is shaping up to be a good year for most of these banks. I think a lot of that is because we should start to see some recovery. We should see that trend of releasing those reserves continue. At some point, I don't know if this is going to be anything we see really in 2021, but we might start hearing some talk about it at least. It is an improving interest rate environment which would then benefit their bottom line as well. Again, I think that's something we would probably hear about a little bit later on. But I think, given the performance of these banks in 2020, again, they were one of the underperforming sectors. I think that things are shaping up to look a lot better in 2021 than they did in 2020. It just goes to show that some of these banks are managed very well.

I think when we talk about CEOs in this space, Jamie Dimon is the name that always comes up to me at least as really the leader of the pack. I would put Brian Moynihan in there as maybe like a 1B. I think he's really, really good and he's been with Bank of America. I think since 2010 he's been running the show there. I think that the longer you have a leader in that type of position who just continues to do the things that he or she says they're going to do, I think that investors have to continue to look at that optimistically. Given the underperformance last year, I could see 2021 shaping up to be a better year for them, no doubt.

Hill: We have a deal in the laser industry, Lumentum is buying Coherent, a rival laser maker for $5.7 billion. This is a cash and stock deal. Wall Street is making it very clear what they think of this deal, shares of Lumentum down 10%, Coherent shares up more than 30%. Is Lumentum overpaying?

Moser: [laughs] Whenever you say the word Lumentum, immediately into my mind it just goes back to that inside joke, ask your doctor if Lumentum is right for you. I just want to get that out there.

Hill: It doesn't sound like a laser maker, it really does [laughs] sound like a pharmaceutical of some sort.

Moser: It sounds like a pharmaceutical you would see during a PGA broadcast or a football game, you're right. I totally agree with that. Every time I hear that, it's just the first place my mind goes. But yes, Lumentum is in the business of lasers among other things, and that's what this deal really is about. This is about getting Coherent's laser business. Lumentum is the company I've talked about on our show here a number of times. It's a company that I've recommended in my services. It's one that's just performed tremendously well over the past couple of years. I think a lot of that has to do with their leadership role in VCSEL, and that's vertical cavity surface emitting lasers. That's the central technology for these devices that we're getting into this whole world of sensors and 3D, imaging, in augmented reality, in virtual reality, stuff like that. VCSEL is an essential technology. For Lumentum as the leader in that space, they've seen a lot of success recently. Part of that is because they have a really big customer by the name of Apple, you probably have heard of it. Apple is responsible for about 26% up Lumentum's revenue. In 2020, it was responsible for 26% of Lumentum's total revenue.

They've been somewhat reliant on Apple, and that's OK because honestly, that technology is needed, but it is also a little bit of a risk. With Lumentum, they have two pieces to their business, the optical communications business, and that's where the VCSEL falls, and that is the overwhelming majority of the business. It's a little sliver of the business that really focuses on lasers though, and that's where this acquisition comes into play. It's a complementary deal in that regard. This is technology Lumentum didn't really have; Coherent, interesting little business that ain't dealing with COVID headwinds I think about as well as they could. It's a smaller company, but it is one that does most of its business outside of the U.S. About 76% of net sales in fiscal 2020 came from outside of the U.S. for Coherent. I do think that with this line of work, there's no question and you can see the benefits of scale, and we're seeing this play out. Look at some of these acquisitions that have been recently announced from all companies, big and small, you've got NVIDIA acquiring Arm, you get AMD acquiring Xilinx, you get Marvell acquiring Inphi, now you get Lumentum acquiring Coherent.

An interesting aspect to all of these deals is that they are part cash and part stock. These are not deals where the companies are just coming in and saying, "All right, we're just going to make cash upfront." I think it's just interesting to note that, because we talk a lot about these lofty market valuations right now, and that's true. That begets some lofty offers, like we're getting with this Coherent deal. But by the same token, these companies are at least using part stock to fund the deal. They're using a relatively cheap form of currency to do that. I think that's just something to keep in mind. It does make sense, I think, in today's environment to do that. I think that with the direction the world is headed, we talk about in microelectronics, we talk about lasers, we talked about VCSEL, and all of these different things this technology is doing. Lumentum and Coherent coming together, it seems like a very complementary deal. The reaction from the market today seems very much in line with the way it normally would react here. The burden of proof is on the acquirer. Understandably, Coherent shares are popping because of the offer. But all in all, as someone who covers Lumentum, I can see this deal working out as long as they are able to integrate it with minimal hiccups.

Hill: I should point out, and you touched on this, I mean, the 10% drop that we're seeing with Lumentum stock, this does come against the backdrop of a stock that over the last two years has doubled.

Moser: Yeah.

Hill: It's not like some deals, where we've seen the acquiring stock drop a little bit, and that's not the case where it's doubled in a short amount of time. I do wonder though, and this is another thing you touched on, I do wonder if we're just going to see a lot more deal making in 2021 than we did last year, in part because as you said, we've got cash and stock deals where the stock has run up, so it's a cheap currency. Also, it really doesn't seem like interest rates are going higher anytime soon.

Moser: No. I don't think they will. We might start hearing a little bit more of that conversation toward the end of this year. That remains to be seen. Even then, we're still looking at a situation where we will probably be witnessing low rates for quite some time. I think that really we're talking about Janet Yellen earlier and she seems to feel like, "Hey, listen, this is the time right now where you got to go big." Let's not just piecemeal this thing together. We're coming out of just one of the most brutal economic times here. COVID is obviously just ransacked the economy from a number of different perspectives. That does seem like at least her perspective is go-big or go home, and part of that going big is going to require interest rates to stay low for some stretch of time until they at least see some signs of inflation coming around. Even then, it remains to be seen exactly how they approach that. Yeah.

I do think that we are in a low-interest rate environment for some time to come. But yeah, it is nice to see, in a time like this, when companies have these valuations, that expands their balance sheet a little bit. It expands their capability of what they're able to do. Nothing's cheap in this market except for maybe banks. That's just something you've got to deal with. But at least on the flip side of that, they are able to use that form of cheap currency in shares, that as long as the acquisition makes sense, then maybe price isn't necessarily as big of a sticking point. Coherent, it's had its fair share of difficulty over the past year. But this is a company with some strong technologies, vertically integrated manufacturing. They do protect a lot of their intellectual property, and I think that's something that Lumentum is -- listen, they're good at what they do. I think they'll bring these guys in and make it work.

Hill: You can follow us on Twitter, @MarketFoolery is the show's handle. Question from Neal and Rockville, "In light of calls for government action against big tech companies like Facebook, etc., if I use the QQQ to any person, 'spread the love', do I protect myself better by going with the QQQE? Thanks. I'll hang up and listen."

Moser: Yes. [laughs]

Hill: Which I love that touch at the end. So thank you for that, Neal. For those unfamiliar, the QQQ is the NASDAQ 100. You can get that in ETF form, and it's basically, we're getting shares of the top 100 companies on the Nasdaq. If I understand this correctly, the QQQE is the NASDAQ 100, but it's equally weighted.

Moser: Yes.

Hill: I have right, where the QQQ is price-weighted?

Moser: Yes. You Q-ed in, I think I'm Q-ed in. You see what I did there? [laughs] That is the main difference there when you talk about these two ETFs. You've got the QQQ, which is market-cap-weighted, versus the QQQE, which is equally weighted, and so that's really just like it sounds. When a fund is market-cap-weighted, it's favoring those big companies more so than the small companies. In the equal weighting scenario, everything is given an equal weighting as it implies. It's not to say one is necessarily better than another, it is worth noting. If you look at the returns over the past three years, the QQQ total returns are up 93.5% and the QQQE total returns are up 70%. There is definitely some outperformance there, and that's understandable because of the market-cap-weighted index, it favors big tech and how big tech is really just been on such a tayar here over these past several years, and that's really the crux of this question is, is that tayar coming to an end? Is regulation such a threat that it could be a headwind for big tech here in the coming year two, three years, what have you?

That's a legitimate question. It really remains to be seen. I just don't know how far this new administration wants to push that. That really is the question to answer. I think when you look at investing in a market-cap-weighted portfolio because you're more concentrated in those big companies, if those big companies hit a wall or performance starts to really slow down, well, then you're going to see your returns reflect that. Whereas that QQQE, that equal weighting, you're going to be less exposed to those bigger companies if they do end up hitting a wall.

Listen, the math is there. You can see over the last several years that the market-cap-weighted ETF has been the way to go. But that doesn't mean that will always be the case. I think, either way, you're pretty well diversified. I tend to feel like this talk of regulation is a bit more bluster than anything else. I feel like they'll probably put these companies through a microscope and scrutinize and whatnot. I don't know that it really bet on any of them being broken up. It's difficult to see that at this point, the two phases out of the two. But anything can happen for sure. I think that either way, you're doing well, owning either one of these, but there's a question to be answered there in regard to regulation and that's just difficult to predict.

Hill: Our email address is [email protected]; from Sebastian in Sweden. He writes, "Love the podcast and hearing about U.S. stocks. However, it would be interesting to hear your take on the Swedish live casino provider, Evolution Gaming, that's kicking ass and taking over the world." [laughs] I was unfamiliar with Evolution Gaming.

Moser: That makes two of us.

Hill: From a stock perspective, he's not wrong. This thing is up about 160% in the past year or so. I'm going to guess you're not overly familiar with Evolution Gaming, but prove me wrong. [laughs]

Moser: Not overly familiar with the company itself. Familiar with the general market, the general idea. We have a service called the Future of Entertainment where we focus on all sorts of different ways entertainment is dictating our lives and certainly sports betting and gambling and gaming are a part of that, and companies like Churchill Downs and Flutter Entertainment, those are companies that have made their way onto our radars. It looks like Evolution Gaming certainly should be one that is, because it is proving that they're on to something. Now, just to give you an idea of what Evolution actually does. They develop and they produce and market, and license live casino solutions for gaming operators. Then the gaming operators take that and they market those products. They offer those products to end-users, like you and me. Evolution's customers are actually these large online gaming operators, primarily in Europe and elsewhere around the world. The U.S. is part of it, but right now, that's really just a tiny part of their business.

I think part of their success has been the fact that it's such an international play. It's not something that's really hinging at success in the U.S. I understand the optimism there because it does feel like these floodgates are starting to open up in the U.S., which is going to give more opportunity for them to grow and they have grown. They've gone from €31 million in revenue in 2012 to $366 million in 2019. The growth is there, and clearly this pandemic has shown the value in digital-first businesses, and that's really what Evolution is. It's giving you the opportunity to participate in your favorite gaming or gambling, whether it's live roulette or monopoly live, or blackjack, or baccarat, or texas hold'em and whatever you want. They really do offer it, and it just essentially they run these games from their studio casinos, so to speak, and allow individuals to be able to participate via their favorite device, whether it's your phone or your laptop. Again, I think this represents a tremendous opportunity. I do understand the enthusiasm behind this name, and it's probably something that we should pay a little bit more attention to.

Hill: Jason Moser, always good talking to you. Thanks for being here.

Moser: Thank you.

Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy yourselves stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill, thanks for listening. We'll see you tomorrow.