Saturday, November 3, 2007

Bank of America purchase

I initiated a position at $45.00 yesterday in one of my 'cheap stocks', Bank of America Corporation (BAC). Here is a brief summary on the company:

Bank of America is one of the world's largest financial institutions, serving individual consumers, small and middle market businesses and large corporations with a full range of banking, investing, asset management and other financial and risk-management products and services. The company provides unmatched convenience in the United States, serving more than 55 million consumer and small business relationships with more than 5,700 retail banking offices, nearly 17,000 ATMs and award-winning online banking with more than 20 million active users. Bank of America is the No. 1 overall Small Business Administration (SBA) lender in the United States and the No. 1 SBA lender to minority-owned small businesses. The company serves clients in 175 countries and has relationships with 98 percent of the U.S. Fortune 500 companies and 80 percent of the Global Fortune 500. Bank of America Corporation stock (NYSE: BAC) is listed on the New York Stock Exchange.

Some Company Highlights

  • Acquired LaSalle Bank Corp. (large Chicago based bank) in 2007
  • Owns a 9% stake in China Construction Bank

  • Owns the MBNA credit card company

  • Serves 76% of the U.S. population

  • Largest U.S. bank

  • Operates all over the world

  • #1 bank in the state of California

  • Bank has a multicultural focus, which are growing demographics

Key Stock Information and Valuation
According to my models the stock is now priced to grow their earnings at a 4-5% clip for the next 10 years

  • Yield = 5.7%, at a historically high level

  • Stock is almost 20% below its 52 week high

  • Price / book value is 1.6, which is lower than anytime except in 2000

  • Return on Equity is always above 15%

  • Dividends have been raised at a very good clip for a very long time.

Rationale for Purchase

The purchase rationale of BAC at these levels is an example of a spot where I think that the risk/reward is tilted far to the reward side. The only real risk with this purchase would be BAC cutting their dividend. Recent analyst remarks regarding Citigroup potentially cutting their dividend have added fuel to fire for the unloading of these banks. There is no greater fear for a dividend growth investor than the potential of a company cutting its dividend. In my opinion this news is partially the reason why BAC is finding new lows. I do not believe BAC will cut their dividend and by making this purchase, I am making a monetary bet on that fact. I really do not much care if more credit writeoffs and further fears cause BAC's shares to fall further, as long as they do not cut the dividend, and continue on their strong history of raises, I may buy more.

Let's use a conservative scenario and assume that BAC's shares are flat after one year and the Canadian dollar remains at these lofty ($1.07) levels; if this occurs my return for the year is about 5.6% (my dividend yield) before tax and I can likely look forward to another dividend increase in August, 2008. Then again if the Canadian dollar should fall, and BAC's shares rise, I would be in a much better situation immediately.

See the charts below for BAC's dividend and share price history.

Dividend History for Bank of America.



Share Price History.









Will there be more pain to come for U.S. banks? How will this affect their shares?

Will Citigroups dividend be cut? Will BAC's dividend be cut?

Will the Canadian dollar remain at $1.07 and above?

All great points for debate. For me the only true question I had to ask to justify this purchase was:

Will Bank of America continue to raise its dividend year after year, and survive this credit crunch just as they have survived every financial crises in the past?

3 comments:

Anonymous said...

BAC is going to take a hit, and probably a significant hit, to its balance sheet on the mortgage writedowns. If interest rates are lowered again, they could also suffer significant MTM losses on the asset side.

Playing the yield curve arbitrage game only works in a declining long-term rate environment. If we are going into an increasing long rate environment, as would be the case if inflation picks up, then BAC, just like all the other banks, likely have very serious issues that you cannot easily deduce from a dividend growth chart, or EPS growth chart immediately.

I assume you've done your due diligence, but these stocks are dangerous just to value based on charts and EPS growth alone, especially during a long-term secular trend of interest rate declines.

Thicken My Wallet said...

The key to valuing any bank is price to book which is, as of today, under the magic number of 1.5 (Graham's magic # as a value stock) and loss loan provisions which you will need to read in their next financials. My general note is that US banks tend to have worse financial risk management then their Canadian counterparts but the Canadian banks tend to suffer from collateral damage when a US bank is in trouble which may be a good time to buy a well-run Canadian bank.

If you want to hold onto to this stock for 5-10 years, the timing is probably about right especially if BAC takes one on the chin and writes down all their bad loans at one go and increases their loss loan provisions dramatically. Assuming this drives down the price, your price to book ratio becomes very attractive but it would be a bad short-term play.

Joe said...

What do you think of DB?

I would like to know some peoples thoughts.