Bank of America (NYSE:BAC) and Bank of Internet (NYSE:AX) are very different. One is huge, and one is tiny. One has thousands of physical locations, while the other has one. But which stock is a better buy right now: Bank of America or BofI Holding? In this segment of The Motley Fool's financials-focused show, Where the Money Is, banking analysts Matt Koppenheffer and David Hanson discuss the hurdles these banks need to clear in order to deliver outsized returns to shareholders.
Full transcript below.
Matt Koppenheffer: Let's move on to the focus. Let's keep some of that fire going.
Our focus for today: B of A, or BofI? We were looking at an article from one of our Foolish writers today, Jordan Wathen. We've got a nice picture of that, right up there. "Better Buy Now: Bank of America or BofI?" Jordan runs through a few different points, looking at the differences between the two. Were you sold in one direction or another, based on Jordan's analysis?
David Hanson: Sold in one direction very strongly? No. I'm sorry, Jordan, you didn't completely convince me!
But I think he points to a really useful exercise that investors can do if they're between two stocks -- or between five, 10 stocks -- and they're trying to find the best one. What he does is lay it out over the next 10 years, saying, "What does this bank need to achieve in the next 10 years, in order for me to get a return that I'm looking for?"
The numbers for BofI and Bank of America, this is how they broke out. I'll say them real quick: If BofI grows its book value at 15% a year for the next 10 years, which would be an incredible run, and it trades at 3 times book in 10 years, you get 12% annualized returns -- pretty darn solid.
For Bank of America to match that, they have to grow their book value at 9% a year, not 15% a year, and only trade at 1.5 times tangible book. You look at the two scenarios and say, "What's more likely?"
I know we can't say with certainty what's more likely for those two banks in the next 10 years, but you can start to think, "How likely is it for Bank of America to do that? What do they have to do to get there?" I think you can get a better understanding of what it has in front of them, in terms of opportunity and also threat, so I think that's a good exercise, just to lay two banks out next to each other and compare and say, "What do the expectations look like here?"
Of those two, I would probably lean toward Bank of America, just because 15% a year for 10 years is still pretty heady growth, in trading at 3 times book, so I was somewhat convinced with Bank of America, but not totally. I think BofI could do it. What do you think?
Koppenheffer: I thought there were a few interesting points to take away, here. You covered some of them.
When you invest in a company with a high valuation, I think that you need to be... first of all, it's got to be growing fast. Why else would you be paying a high valuation if it's not growing fast? But you have to be ready to hang onto it for a long period of time. Like you said, Jordan was talking about 20 years, because it's over that time period -- that kind of time frame -- that the compounding and the growth can really pay off for you, despite the high initial valuation.
A corollary to that, I think, is that when you're thinking in those kind of long terms, a high valuation does not need to be a show-stopper. If you legitimately think a company can maintain high rates of growth for a long period of time, you can pay a higher valuation and still get a really great return. Getting 9%, getting 10%, getting 12% per year over a very long period of time is very meaningful.
Now one thing Jordan, in his analysis, looked at what would happen if the price to tangible book value for BofI fell down to 1 times. I think investors have to be prepared for scenarios like that, but again, if you're assuming that high rates of growth will continue, the likelihood is that the valuation won't fall that much.
If you look at a really fast grower as a high valuation, maybe the peak valuation that it's at right now won't maintain, but you'll probably still have a relatively high valuation, as long as the growth continues. The problem is that if the growth doesn't continue, you face that double-whammy of, now you have a slow grower and the valuation is going to fall drastically, so you're going to lose on all fronts.
I would say that my bottom line -- kind of along the same lines as you -- I lean more toward Bank of America in this comparison, and it's not necessarily just because of the high valuation of BofI. My concern is mainly that I'm not 100% sold on BofI's model. I worry just a little bit when I see certain financial services companies, particularly within insurance and within banking, growing very fast. It can be done, and it can be done right, but it gets more difficult because it's a risk management business.
I'm not saying that BofI hasn't done a fantastic job so far, but there are a lot of unknowns when you have a young financial services company, growing very fast.
Hanson: Yeah, and to step back from the numbers for a second, we talk about the business model and what's potentially sustainable for 10 years. It could be a great model that BofI has, but I'd be more willing to bet that Bank of America's business model is more likely to be around in 10 years, with the investment bank, with the wealth management, with the mortgage lending. I would bet that way, that their model's more sustainable.
Koppenheffer: Even on the consumer banking side of Bank of America, I think one of the big attractions of Bank of Internet is that it's this technology-enabled business; we're seeing the ability to bank over mobile devices, to bank on the Internet.
But Bank of America has not at all missed out on this. Bank of America has maintained a high level of deposits, despite trimming branches -- Patrick Morris wrote an article about that for us this past weekend -- and has been aggressive in growing its mobile banking business and its online business, and that's good for Bank of America, so it's not missing out on that great technology.
Will B of A lose the battle?
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David Hanson has no position in any stocks mentioned. Matt Koppenheffer owns shares of Bank of America. The Motley Fool recommends Bank of America and BofI Holding. The Motley Fool owns shares of Bank of America and BofI Holding. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.