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Don't Let Bank of America Ruin Your Portfolio

By John Grgurich - Apr 1, 2013 at 2:38PM

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Three benchmarks for helping you evaluate whether you should be in this investor darling.

Before anyone gets too bent out of shape, let me state first off, this isn't a Bank of America (BAC 5.94%) attack piece, per se (though regular readers will know I'm bearish on B of A).

This article is meant to point out the dangers in general of owning shares in a company you don't fully understand: the havoc any stock can wreak on your portfolio if you don't know when to buy more, when to sell it all, or when to just sit quietly and do nothing.

B of A is a good case in point primarily because it's a sprawling leviathan with a complex business model that defies straightforward analysis even in the best of times, and the last few years have been anything but the best of times for B of A.

To that end, here are three benchmarks to think about when looking at B of A as a potential investment: a quick guide to knowing whether or not your money should be anywhere near the superbank's shares.

1. Valuation
The price-to-book ratio is way to evaluate any company, but is a favorite method for bank investors. P/B compares a stock's market value to its book value, and gives you some notion of what the company would be worth if it went bankrupt and was put on the auction block tomorrow.

B of A's P/B is a staggeringly low 0.60. Some investors look at this and see a big green light, a potential bargain: "Hey, this bank is way undervalued. Let's scoop a bunch of its stock up!" Other investors, like myself, see a flashing red light: "B of A's P/B is low -- too low. There must be something fundamentally wrong with the company. I'd better stay away."

Even Citigroup (C 6.07%), a company with its own complicated operating model as well as a complicated past, has a P/B of 0.72. I own a few shares of Citi myself, so for me, 0.72 is low, but not frighteningly low.

2. Earnings reports
For the fourth quarter of 2012, B of A's revenue shrank 20.7% year over year, along with its net income, which shrank 63.2%. For the same period, Wells Fargo (WFC 5.16%) grew its revenue by 8.1% and its net income by 23.9%. JPMorgan Chase's (JPM 6.19%) numbers were 19.2% and 52.7%, respectively.

B of A can chalk up that pitiful performance primarily to its misdeeds and mis-moves committed during the housing boom -- and the resulting payouts to government agencies to right said wrongs. How much longer will B of A have to keep up this sort of bottom-line-robbing activity? The fact is, no one knows, no matter what anyone says differently.

3. Return on equity
Return on equity, or ROE, measures the amount of net income a company makes with shareholder money and is another popular metric for measuring banks. B of A's is 1.79%.

To put that into perspective, consider that JPMorgan's ROE is 10.98%. Wells Fargo's is 12.89%. Even Citi -- another superbank atoning for its financial-crisis sins -- can manage an ROE of 4.27%.

Gone forever are the days when the big banks could have ROEs in the 20% range (ah, the pre-crash era). But 1.79% means that B of A is hardly doing anything with your investing dollars.

Foolish bottom line
B of A is trying to dig itself out of a very big hole, one largely of its own making. If you don't fully understand the dynamics driving its business, stay away (one of the reasons I'm not invested). There are simply too many good banking investments out there to risk blowing up your portfolio with a black hole like B of A.

JPMorgan and Wells Fargo are cases in point: Both bank relatively conservatively, but perform well for investors. Banks don't have to be blind rolls of the dice, even ones with trillion-dollar balance sheets. 

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Stocks Mentioned

Bank of America Corporation Stock Quote
Bank of America Corporation
$35.87 (5.94%) $2.01
Citigroup Inc. Stock Quote
Citigroup Inc.
$52.77 (6.07%) $3.02
JPMorgan Chase & Co. Stock Quote
JPMorgan Chase & Co.
$124.60 (6.19%) $7.26
Wells Fargo & Company Stock Quote
Wells Fargo & Company
$43.82 (5.16%) $2.15

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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