Bank of America (NYSE:BAC) has surged nearly sevenfold since its March lows. After this epic run, it's worth asking: Are shares getting ahead of themselves, or are they still worth buying?

The bank now has a $145 billion market cap, so the question should be whether it can stabilize and start to earn something in the neighborhood of $10 billion to $15 billion per year.

Could that happen? Anything could ... but I sincerely doubt it'll happen anytime soon. Excluding one-time gains and accounting sorcery, the bank is still losing gobs of money. Potential losses on existing assets are both real and menacing. Assuming that kind of profitability reminds me that some people may have downed one too many green-shoot aperitifs.  

But no matter: I'll play the bull's card today to try to prove a point.

To estimate B of A's earnings power, we have to look at the previous profits of its three parts: Vintage B of A, Merrill Lynch, and Countrywide.

Using average 2004-2006 earnings, here's what each segment was able to earn:


2004-2006 Average Net Income

Vintage B of A

$17.2 billion

Merrill Lynch

$5.7 billion


$2.5 billion

Source: Capital IQ, a division of Standard & Poor's.

That's a total of about $25 billion ... not bad considering the $145 billion market cap!

But let's be real: 2004-2006 was nothing close to normal. Or rational. Or sustainable. It was a bubble. A big one. Real estate prices could find no top. Unemployment was 5%. Doctors got less respect than mortgage brokers did. Merrill Lynch was leveraged almost 20-to-1 and was the world's largest underwriter of collateralized debt obligations.

Those days are toast, thank goodness. It's only sensible, then, to take 2004-2006 earnings and trim them down to reflect today's reality.

By how much? When I look at nearly 10% unemployment, real estate prices that are still falling, credit card and commercial real estate exposure, and profits that were juiced by excessive leverage, a 40%-50% haircut doesn't seem unreasonable, even with synergies and cost savings. The fact that B of A is still losing money while interest rates are at zero should validate this contention.

With that haircut, we'll assume earnings of something like $12 billion to $15 billion a year when the smoke clears and the economy grows at "new normal" rates. This assumption is quite generous, and it's actually about twice what analysts expect it to earn in 2010.

But let's say it happens. The $145 billion market cap might suddenly look fair in the eyes of an optimist. It's close to the equivalent valuation at which rivals JPMorgan Chase (NYSE:JPM), Goldman Sachs (NYSE:GS), and Morgan Stanley (NYSE:MS) trade -- even though they're far healthier.

So everything's cool, right?

B of A still owes taxpayers $45 billion, plus a few billion in warrants. CEO Ken Lewis has reiterated his intention to repay the money before he leaves his post (and many wish he would hurry it along), and he says repayment could start as early as this year. With executive-pay restrictions knocking at his door, though, he can be forgiven for wanting to rush this process through.

But where's that money going to come from? To maintain capital levels, it'll come either from earnings -- which would soak up several years of profits -- or, more likely, from issuing common stock. While it's impossible to know when or at what price stock sales might occur, one thing is assured: When it happens, it'll be severely dilutive to common shareholders.

So, sure: Wildly optimistic assumptions might make B of A look fairly valued in the eyes of optimists. But when you consider the obligation and urge to repay taxpayers as soon as possible, dilution could quickly turn what looks fair into something that's far overvalued.

And this all assumes that the opacity and accounting gimmickry that are standard in today's banking world don't turn B of A into the next Citigroup (NYSE:C) or AIG (NYSE:AIG). If you think that's an overly dramatic statement, read through B of A's annual report and see whether you can truly decipher its balance sheet and understand how banks value assets. You'll see why this company enjoyed hiring people with Ph.D.s in physics.

Your turn to chime in
I realize this is a quick-and-dirty analysis fraught with assumptions, some of which you may think are totally nuts. So I'll hand this over to you. What do you think of B of A: Are shares a good buy or way overpriced? Take a moment to share your thoughts in our poll, or post your comments in the box below this article.

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Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.