Bank of America Looks Well Positioned to Rise Further
There are a few ingredients that are helpful to drive a company’s stock higher. Bank of America is a nice mix of business performance, buybacks, and increased optimism.
Bank of America CEO Brian Moynahan isn’t quite as famous or even as well regarded as JP Morgan Chase’s Jamie Dimon, the darling of big bank CEOs, but he has more quietly been doing a great job in steering one of America’s biggest financial institutions on a path to long-term success.
We remember what happened to the stock market back in 2008, at the height of the financial crisis, where we were days away from the collapse of the entire global banking system. We survived though, thanks in part to the work of people like Moynahan and Dimon. While Bank of America is still clawing its way back to where it was in 2006 before this all started, being a veteran of that great financial war certainly has its benefits.
Big banks and other financial institutions were making money hand over fist prior to this collapse, and all these years later, free of any major incidents that would have stymied the recovery, and with very good leadership all the way, Bank of America still hasn’t even come close to matching the $4.59 per share that they earned in 2006.
We’ve come the closest yet in 2019 though, even though we’re still off by almost $2 a share in earnings. Bank of America stock is still off its high-water mark of $55.05 per share in 2006 by over $20 a share, so there’s still quite a way to go yet to catch up on that front as well.
We may be tempted to say that this looks like a stock and company that is still pretty beat up, and while they have managed to pull up their bootstraps quite a bit since, their 233% gain over the last 10 years is below average, and we should never be willing to settle for that.
We don’t want to just ask what a stock and a company has done for us over time, we need to also ask what they have done for us lately. All data is not equal, and especially with stocks which trend a lot, we need to know what the current trend has been like as this is a more reliable indication of how things are going than anything that happened 5 or 10 years ago.
We also don’t just want to look at past performance, we want to seek to tell a story of where it has been and where it might be headed, according to the conditions we identify as influential. Bank of America is being promoted as a nice play by the analysts right now, and while we often will look into these things and decide that their claims are far weaker than they believe, this play really does measure up on several important counts aside from the usual fare that analysts look at.
We can start with the chart, and we always need to do that, since the chart tells such a big story. When our ideas and the chart disagree, this in itself tells us that we are wrong, because the chart gets to decide these things. If we think that things will improve but the market does not, either the market changes its mind or we will be mistaken. If the market does change its mind, it will speak to us by way of its chart, so charts are both useful and necessary.
Seeing Bank of America emerge as a market outperformer in 2019 is therefore an essential element of our wanting to recommend it, because otherwise, it simply has not shown us that it is ready. There are other things to look at besides this, but we can have every duck in a row with our bullish recommendations but this one and this tells us that the time is simply not right, because the market for the time being believes otherwise.
Bank of America gained 38% last year, and its earnings rose by 67% year-over-year, the fifth consecutive year in which earnings grew. When you have both the technicals and the fundamentals on your side, this presents a good opportunity for both those looking to just ride the moves up and those who are interested in staying around for much longer.
Aside from both their business and their stock growing, if we’re considering a stock beyond just trading the charts, where the chart provides you with all the information you need and you just get off when the line starts going down, we do need to look at the story behind the story, why the stock has done better lately and what we may expect to continue to influence it going forward.
The biggest influencer of stock prices, and the only one ultimately, is investor outlook. Many things shape this outlook, but it is the outlook itself that ultimately tells the story. This is the big part that the fundamental analysts miss because they don’t even consider it to be an influencer, because it doesn’t fit their beliefs.
Investor Outlook is Particularly Important with Bank Stocks
There is no better type of stock to look at to show how outlook affects stock prices though than bank stocks, including Bank of America, because their outlook has changed so much over the past few years in a way that takes us way beyond the ability of the business model to explain.
Let’s start by looking back to February 2009, and this was at a time where we beat back the flames of the financial crisis and things were starting to turn around for stocks. Bank of America stock wasn’t just in the doldrums, it was in the toilet, dropping all the way from its $55.05 high to trading at $2.53 a share.
This took us to the point where the bank was only being valued by the market at less than 5% of its prior value. The bank had fallen upon hard times, to be sure, but nowhere this hard, not even remotely close.
When we value a stock, we do so from a forward-looking perspective, and this was a bank that came out of the crisis pretty intact, unlike some who met with much more misfortune. Bank of America lost 66 cents per share in total during 2009 and 2010, but this actually had not even happened at the time the stock sunk to this low.
Instead, they lost over $52 per share over a time where they earned $8.42 per share in the period between the high in 2006 and the low in 2009. We knew that they were at risk of a loss at that time, but the expectation was that the losses will be well contained, which they were, and that the bank would recover, which it did. The net change in earnings even deducting the 66 cents which was yet to happen was $7.86 a share, several times higher than the amount that put us up by 38% last year.
What makes this drop look even more bizarre is just how cheap it had become, and when the total cost of the stock is less than just one year’s average earnings, that’s just ridiculous.
It was not business performance that drove this down, and while this little interlude from profit making might have reasonably justified a few percent reduction in their long-term outlook, the rest of it can only be explained by changes in investor outlook, where it became driven by fear, which drove it down so much.
As the stock kept going more and more down, there surely had to be a point well above where it went to, that value investors would step in and take control, but this even served to scare them away until things finally got so low that it really couldn’t go much lower, where enough who were prone to this fear got out that there just weren’t enough left still afraid.
Make no mistake though, this is a move that should strike great fear in our hearts, and it’s not like it was wise to ignore this. Those who held fast lost the most though, the maximum amount actually, while wiser investors got out when things turned bad and were able to get in once it was over, which saw them enjoy the difference where they got out and got back in as an advantage.
It certainly helps to have business performance on your side, but not all the time, and this is never enough. In 2018, Bank of America had its best year earnings wise since 2007, and the projections for 2019 were looking even better, which did come to pass. Their stock lost 16% that year though, which only makes sense when you realize that some other force caused this, the force of investor sentiment.
Why would investors sour on a company that is doing so well though? 2018 was a slightly down year, but this stock simply got punished, as did bank stocks in general. The bank did well in both 2018 and 2019, so how can we explain it losing 16% in one year and gaining 38% the next?
The reason behind this provides us with the first part of the story behind the story, and a big part of it indeed, since this thing can produce such divergent results over two good years with earnings continuing to trend upward.
This all has to do with interest rates, and while banks can do well with higher rates, this refers to the business, not the shares. Investors already take a bearish view of higher interest rates, which they use to punish stocks, and punish bank stocks even more, whether it makes sense to do or not.
This is all you need to know, as there is no sense trying to explain it with a business model, this can only be explained by describing this tendency and writing it all off to just the way people behave with bank stocks when rates are higher.
The 16% loss happened in a year when rates went up, and the 38% gain happened when they went down. Bank of America, in fact, earned all of its gains in 2019 from August onward. It traded flat when the rates were flat and went up by 38% when they went down.
Bank of America Has Several Key Things Going For it Now
Given that rates are both low and expected to be for a while, this is a big reason why Bank of America remains attractive, and a much bigger reason why than the fact that they are making more money. We really want and need both though, but we have both right now.
The optimism has picked up toward bank stocks, and perhaps it took this long for us to really set our fears aside to give these stocks the due that they deserve based upon how well their banks are doing. While business performance does matter, it only matters when confidence is high enough, and confidence isn’t just the biggest driver of stock prices, it’s the only driver.
We ignore levels of confidence at our peril. No matter what else may be on board, if you don’t have the right amount of confidence, the aircraft will simply not take off and will crash at the end of the runway, leaving us still clutching our reports with our blood now spilled upon them.
There is no more important criterion in entering or holding a bank stock than interest rates as it turns out. Given how fabulous things are on this front right now, there is no better reason out there to be bullish on them.
As far as whether or not it makes sense to have more confidence in bank stocks at lower rates, this does not matter at all because the facts speak for themselves. However, the fact remains that Bank of America made 67% more money in a year that saw rates decline than in a year where we saw them go up. Low rates suit them just fine, pretty well actually, which we also need as part of our story lest we see declining business results weigh in due to the current interest rate climate.
There’s also the fact that Moynahan has learned his lesson and now steers the bank well clear of the risky stuff, which has us feeling better about going with it longer-term. While bank stocks are still prone to shocks caused by other banks, and this does not escape much of that risk, it at least has us feeling better about the stock’s recovery if this happens. While we would still want to step aside at this point, those who are not up for this can rest easier.
While the stock’s outlook and momentum are the biggest pieces of the puzzle, and it’s nice to see the bank move forward profit wise like this, and it’s nice to see it have such strong leadership in Moynahan, there is another reason why we really like this stock here, and it’s Moynahan being such a champion of stock buybacks.
Banks really can’t do much on the expansion side and have a lot of money left over at the end of the year to disperse. Most choose to pay a lot of it out in dividends, and while Bank of America pays one as well, they only pay a very modest 2%, even below the average of the market.
A lot of CEOs get stock buybacks, but Moynahan really gets it, and has a lot of money to spend on this as well. Moynahan has been one of the people who have come under attack in Congress by Democrats who fancy themselves as armchair CEOs and they want the real CEO to defer to their visions of how their business is to be run.
One of the things that troubles these politicians is that buybacks worsen wealth inequality, which is simply a ridiculous objection. A company makes decisions that seek to benefit its shareholders, of various degrees of affluence, and expecting a CEO to make a decision to act against their economic interests, such that the wealth gap would not be increased when it could have been, requires that we delight in the misfortune of others to have it make any sense.
Moynahan has stuck his tongue out at them and that’s exactly what we want to see, a buyback fan who will not be swayed by someone else’s preferences. With the bank now making more money now, there is even more to spend, and he’s ready.
Buybacks are all the rage now, and this can be a far more powerful tool to drive stock prices than we generally believe, and the rally in 2019 was caused by the power of buybacks alone, as we took more money out of stocks than we put in and this would otherwise produce a down year, not a big up year.
Of all of the things that we’re looking at, the extent of the buybacks planned for this stock is perhaps the most persuasive of all reasons, but they are all interconnected and required. If we were still afraid of this beast, buying back stocks in this scenario may not overcome the negativity, and we need things firing on all cylinders for buybacks to achieve their potential.
We have that with Bank of America though, and this is a stock where people are blowing their horns for, and they actually should.
Editor, MarketReview.com
Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.
Contact Monica: monica@marketreview.com
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