What a year it's been for Bank of America (BAC 0.63%). The stock price is up 47% this year and is more than double the lows it hit at the very beginning of the pandemic. At about $44 per share, the stock is at its highest level in more than a decade. Warren Buffett knew what he was doing when he plowed more than $2 billion into the stock in mid-2020. With a premium valuation, can America's second-largest bank by assets go higher in 2022? Let's take a look.
What to expect in 2022
This year's earnings at most banks were lumpy, with billions in reserves being released after previously being built up to manage loan losses that didn't materialize. Banks also generated record revenue for investment banking and sales and trading, but then saw slacking loan growth in the extremely low-rate environment.
That's why analysts' consensus earnings per share (EPS) estimate for Bank of America in 2022 is $3.17, down from the $3.51 expected this year. But while EPS is estimated to shrink, Bank of America's revenue is projected by analysts to grow from just shy of $90 billion this year to more than $94 billion in 2022. The releasing of billions of dollars of reserves this year artificially juiced earnings after a tough year in 2020, so that will likely go away as loan balances start to tick up, which inevitably requires banks to stash away reserve capital for the normal course of losses expected over the life of a loan portfolio.
However, with inflation now very real, Bank of America's research team sees the Federal Reserve hiking its federal funds rate three times in 2022. It's one of the most asset-sensitive banks in the country, meaning the yields on more of its interest-earning assets such as loans will reprice higher than yields on its interest-bearing liabilities like deposits.
In its third-quarter presentation, Bank of America management noted that a 1% parallel move in short- and long-term yields would result in more than $7 billion of net interest income over the next year. Assuming three rate hikes, the bank will get a lot of that added net interest income. And who knows: If loan growth can pick up, that could boost net interest income more.
The outlook for investment banking and sales and trading is also likely improving for 2022. After phenomenal performances in 2020 and early 2021, many thought these lines of business, which tend to thrive during periods of volatility, might settle down -- and fixed-income, currencies, and commodities trading has slowed from record levels seen earlier this year.
But JPMorgan Chase analysts released a research note in October that said as inflation gets higher and bond yields creep up, that will likely create more volatility in the markets, which is when trading can pick up because there is less liquidity. With the Fed speeding up the tapering of its bond-buying program, this will also reduce the amount of liquidity in the market.
Also, Bank of America is coming off a strong year in investment banking with lots of mergers and acquisitions activity. In multiple quarters this year, Bank of America generated more than $2 billion in investment banking fees, which was near record levels. CEO Brian Moynihan said at a recent conference that he thinks the team can get another quarter topping $2 billion in the future.
With a bullish outlook in so many of Bank of America's business lines, and considering that the bank is currently buying back a lot of stock, I am optimistic that 2022 can be another strong year for earnings.
How to value the stock
Banks trade relative to their earnings and also to their tangible book value (TBV), which is what a bank would be worth if it were liquidated.
Over the past five years or so, Bank of America has traded in a range of about 7 times earnings to close to 20 times earnings. Most large banks trade in the 11-to-14 window. Its price-to-tangible book has ranged from around 100% to 200%, and 200% is certainly a strong price-to-TBV ratio in this low-rate environment.
But Bank of America, in my opinion, is in the strongest position it's ever been in. The bank has significantly enhanced its corporate and investment banking division, improved its deposit base, and continues to be a dominant commercial lender. Its digital capabilities are much better now as well, which will pay off as the pandemic has accelerated digital banking trends.
Banks also solved a huge reputational issue during the pandemic that has dogged them since the Great Recession. They escaped a significant and rapid downturn with superb credit quality and were part of the solution this time around instead of the main issue behind the meltdown. Because banks looked so bad coming out of the Great Recession, I think investors have been very wary to return to them.
For all of these reasons, it wouldn't be unreasonable for the bank to trade at an earnings multiple in the upper echelon of its previous range. While some of the benefits of rate hikes have been priced in, I think a large-cap bank stock like Bank of America could trade at 15 times earnings, which it traded around the last time rates rose in 2017 and 2018. With EPS estimated at $3.17 in 2022, that implies a share price of $47.55, which does not imply a ton of upside from the current stock price.
Again, some of the benefits I've discussed from higher rates are likely priced in, but those earnings estimates from analysts for 2022 could certainly be conservative, so there could be further upside as well.
Are there higher-growth opportunities elsewhere? Probably. But on a much longer-term basis, I have all the confidence in the world that Bank of America can keep delivering strong and consistent returns for investors.