If you're a shareholder of Bank of America (NYSE:BAC), as I am, then maybe you've thought about the single most important question that will dictate the future performance of its stock: How much can the bank earn once it's firing on all cylinders?
If you believe Bank of America's chairman and CEO, Brian Moynihan, then the answer is: $21.6 billion a year. That, at least, is the bank's target, which comes straight from the horse's mouth, so to speak. According to Moynihan's 2015 shareholder letter:
Our return on assets [in 2015] was 0.74 percent. Our longer-term target is 1.00 percent. The gap shows we still have work to do. However, our target is realistic, driven by continued loan growth and good core expense management.
The math is simple. Bank of America earned $15.9 billion last year. That equated to 0.74% of its average assets, which added up to $2.16 trillion over the 12 month stretch. If it were to meet its target of a 1% return on average assets, then, it would need to earn $21.6 billion. That's $5.7 billion more than it's earning right now.
What would this do to Bank of America's share price? Assuming that Bank of America's stock would at that point trade for 1.2 times tangible book value per share, which is a back-of-the-envelope estimate but nevertheless reasonable in my opinion, then shareholders today could be looking at 37% gain.
It's worth noting, moreover, that this estimate doesn't take into consideration the likely fact that Bank of America's tangible book value per share will continue to grow before it reaches its profitability target. Last year alone, for instance, the bank's tangible book value increased by 8%, according to the bank's latest proxy statement.
This drives home a critical point. Namely, Bank of America doesn't need to generate the same type of profitability as, say, Wells Fargo does, which returned 1.32% on its average assets last year, to still provide a significant return on investment.
This, in fact, is exactly why I own its shares. As I've expressed in the past, I have little confidence that Bank of America, as it's presently constructed, can compete on a level playing field against Wells Fargo or, for that matter, JPMorgan Chase. But it doesn't need to in order to produce a substantial return on investment given its current share price.
One caveat is in order. That is, Bank of America's board has set CEO Brian Moynihan's performance-based compensation to kick in only if the bank earns 0.8% on its assets over the three-year stretch from 2015-2017. That's below the 1% target expressed in Moynihan's shareholder letter. However, because it's an average, added to the fact that the bank earned less than that last year, there's every reason to believe that both Moynihan and the bank's board of directors believes that the 1% return on assets target is indeed achievable.
John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short May 2016 $52 puts on Wells Fargo. The Motley Fool recommends Bank of America. 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.