A Safe Way to Make 30%

Written By Briton Ryle

Updated September 6, 2023

I've been telling anyone who would listen that Bank of America (NYSE: BAC) is one of the safest investments out there.

I wrote about it here in Wealth Daily in March of 2013, when it was trading for $12 a share.

I said it again in August 2013, when shares were around $14.

And I'm on record saying I still think good ol' BofA will be a great performer this year.

Yeah, I know, people hate Bank of America. And banks in general don't have the earnings power they did before the financial crisis because of new regulations from the Dodd-Frank banking bill.

And speaking of financial crisis, investors still seem to be worried that banks aren't healthy.

Besides all that, Bank of America is boring. There's no story, no significant innovation… just a bunch of branches and ATMs.

I don't invest to be cool or flashy or smart; I invest to make money. And when I invest, I want the odds to be as much in my favor as I can get them. I want the risks to be as moderate as possible, and I want the business I'm investing in to have a clear road to a higher valuation.

Define Your Risk

There are several ways to define risk when investing.

You can define risk with position size on the idea that a smaller position size is inherently less risky.

You can define it by using a stop-loss, saying, for instance, that if the stock falls 10%, you sell it. Want to give it a try yourself? Check out our position size calculator.

I like to define risk in terms of the company's business. What are the risks that the company can't execute its business plan and will thereby fail to grow?

In the case of Bank of America, there have been three main risks to its business over the last couple of years. The most obvious was mortgage-related settlements stemming from its disastrous Countrywide acquisition. So far, BofA has paid out something like $70 billion in settlements.

Last year, these settlements caused BofA to report losses in two quarters. I'll admit it was no fun watching that tab rise… $20 billion here, $15 billion there.

But in terms of risk to the business, these settlements were not long-term problems — they were one-shot deals. Settle with the DOJ, and you're done. Settle with Fannie Mae, and you don't have to do it again.

The second risk is that the bank still had a bunch of toxic debt on the books that would require further write-downs.

And the third was that Dodd-Frank would fundamentally change the business.

Now, when we're talking about the risk to a company, you also have to ask how much of the risk is known to investors and how the stock is priced to account for it.

Bank of America has traded at or below tangible book value for the last three years. Tangible book value is a leaner version of book value that doesn't take into account intangibles like the value of the name "Bank of America" — otherwise known as goodwill. 

Tangible book value is sometimes referred to as "bricks and mortar" value because it simply looks at the value of the assets (buildings, equipment, cash, etc.). I believe the fact that BofA has traded near tangible book value says that investors were accounting for the risks to the business model — i.e. settlements, potential bad assets, and Dodd-Frank restrictions.

In other words, yes, the risks were real. But it wasn't like investors didn't know what the risks were. The stock was priced for them.

The Potential Return

Right now, Bank of America trades at 0.75 times its actual book value (which will always be higher than tangible book). It is cheaper than any other big bank — cheaper than Goldman Sachs (1.17 times book), cheaper than JP Morgan (1.05 times book), even cheaper than Citigroup (0.81 times book).

Sure, you could argue that BofA has (had?) more risks than the other banks and that it deserves to be cheaper. I would agree (except in the case of Citi). But what about when the risks change?

BofA is basically through with mortgage settlements. It has adjusted for Dodd-Frank. And while I don't for a minute believe the Fed's bank stress tests give us a 100% accurate picture of a bank's assets and liabilities, I also don't believe the tests are a complete sham.

In case you missed it, the Fed's 2015 stress test results were released last Thursday afternoon. Bank of America was one of the best performers.

Bank of America did pretty well last year, too, and was allowed to raise its dividend form $0.04 to $0.20. Last year, Citi's request for a dividend hike was rejected. It still sits at $0.04.

So according to the Fed, last year Bank of America was in much better shape than Citi. And yet it is also cheaper.

We will get the latest dividend hike approvals later this week. I expect both BofA and Citi to get approval for dividend hikes. But given that BofA did better than Citi on the tests, it should be approved for a better dividend hike.

I'll say it again: Bank of America is cheaper than Citigroup.

Book value for Bank of America stands at a little over $21 a share. The stock finished Friday around $16.30.

Will Bank of America rally 30% to trade at book value like the other big banks (the ones not named Citi)? I don't know. But I think it's a pretty good bet.

Until next time,

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.

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