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The Sparks That Could Light Bank of America on Fire

By Alexander MacLennan - Jan 25, 2014 at 10:00AM

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Even after a 2013 rally, more could be in store for Bank of America.

Source: Gabriel Pollard on Flickr.

Last week marked the first big bank earnings season of 2014, with all four major banks reporting earnings. A standout among the reports was Bank of America (BAC 1.68%), which beat estimates for both earnings and revenue. Going into 2014, there's upside for this megabank and a few key catalysts that could spark the shares to climb higher.

Earnings reports
Not only did Bank of America beat analyst estimates last quarter, but the results marked a sharp increase in earnings over the same quarter from the previous year. However, this cannot all be explained by growth and cost cuts. Last year, Bank of America took charge relating to a lawsuit with Fannie Mae that dealt a blow to earnings.

Despite last year's reduced earnings being largely the result of a one-time event, investors like to see solid earnings, one-time charges or not. As Bank of America settles lawsuits (more on this later), these one-time charges should become less frequent, resulting in higher earnings going forward.

The courtroom has been like a second home for B of A recently.

Life in the courtroom
Bank of America has been embroiled in legal troubles since the financial collapse as institutions and individuals seek damages for the bank's actions leading up to the financial crisis. Adding to the legal mess was Bank of America's takeover of Countrywide Financial, which caused B of A to largely assume legal responsibility for Countrywide's sketchy mortgage practices.

Bank of America CEO Brian Moynihan has taken the strategy of settling lawsuits and knocking out the bank's legal troubles as quickly as possible. Among the biggest settlements on the table is a $8.5 billion settlement with a group of plaintiffs concerning mortgage-backed securities issued by Countrywide. The settlement has already been written up, but some plaintiffs, including bailout poster child American International Group (NYSE: AIG), have objected to the settlement accusing the trustee of failing to properly perform its duties.

If the settlement is allowed to proceed, it would clear away a big chunk of uncertainty from the bank and it for the cost of only $8.5 billion.

Recent reports indicate that a ruling may be close at hand. The judge to rule on the case, Barbara Kapnick, has been promoted to the appellate division and expects to rule before taking the position next month. A decision on this settlement could be in hand in a couple weeks, clearing up a major piece of uncertainty haunting Bank of America. A positive ruling could be a major catalyst for B of A, while a negative ruling would hurt shares -- at least in the short term -- as the case goes back to litigation.

Source: Mike Schmid on Flickr.

Padding your pockets
In March, we should get a clearer picture on whether Bank of America can raise its dividend above the penny per share level. Right now, the dividend has little purpose but to attract dividend-only funds and allow the bank to say how many years in a row it has paid a dividend.

If the Fed grants Bank of America permission to raise its dividend in March, possibly to a level competitive with Wells Fargo (NYSE: WFC) and JPMorgan Chase (NYSE: JPM), it could bring more buying pressure by income investors. At this moment, income investors bullish on large banks only have Wells Fargo and JPMorgan Chase to pick from, but Bank of America could join this club in the next few months, sparking another upward move in its share price.

How high?
Bank of America may have more room to run in 2014 as earnings grow, legal uncertainty dies down, and a meaningful dividend is instated. Using 2014 earnings estimates of $1.33 per share, with a 15 times multiple (multiple expansion generated through reduced legal risks) we get an end-of-year estimate of around $20 per share.

Bank of America also trades at a sharp discount to its book value. While it could be a while before B of A trades at a significant premium to book value as seen at Wells Fargo and JPMorgan Chase, the factors described above could get Bank of America to 1.0 times book. Book value stood at $20.71 on Dec. 31, 2013. If we assume a conservative 3% growth in book value for 2014, we get a year-end estimate just north of $21 per share.

Two separate valuation methods point to a 2014 year-end share price of $20 to $21 per share for Bank of America. With catalysts to move shares higher, and the potential for greater dividend income, investors have good reason to be bullish on Bank of America for 2014.

Alexander MacLennan is long January 2015 $20 calls on Bank of America, long Bank of America Class B warrants, and long AIG warrants. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool recommends American International Group, Bank of America, and Wells Fargo. The Motley Fool owns shares of American International Group, Bank of America, JPMorgan Chase, and Wells Fargo and has the following options: long January 2016 $30 calls on American International Group. 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.

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