As a follow-up to my thoughts on IPI, I wanted to share three high level reasons why I think Bank of America is also a compelling investment. As a reminder, please don’t forget to check out our disclosures and please don’t invest money without consulting a professional or being prepared to suffer through regular and unexpected market volatility.
#1. I don’t think Bank of America can easily get killed — and there are a lot of people double and triple checking its numbers.
Bank of America is the largest investment in my portfolio, making up 88% of my non-retirement, discretionary investment portfolio. Obviously, this pie chart keeps me up at night:
Kidding. It’s my largest position because I believe it’s a relatively safe investment (also see point #3 below).
After surviving the financial crisis and under constant scrutiny as a Global Systemically Important Bank, there are a lot of investors, auditors, accountants, regulators, politicians, employees and bureaucrats that scrutinize its numbers and restrict its activities.
Furthermore, the CEO Brian Moynihan has struck me as a pretty conservative custodian rather than a typically flashy and hyper-ambitious Wall Street executive.
This isn’t to say that risk couldn’t be hidden somewhere, and the company can be extremely complicated, but the CEO has made it a point to simplify the business while its capital ratios (an indicator of financial strength) keep getting stronger year after year.
#2. It’s a cash flowing machine — and should interest rates rise as expected, it’ll only make more money.
This past quarter, the company surprised investors with $0.41 of earnings per share due to increasing revenue and ongoing cost-cutting initiatives. Annualized, that means the company is on track to generate over $1.60 of earnings per share going forward, assuming zero growth, no more cost-cutting and zero interest rate increases.
I believe all three of those assumptions are wrong — but even one of them will continue to increase earnings per share.
At $1.60 of annualized earnings per share, that’s approximately 10% return on the company’s ~$16 per share stock, and up to 32% of its $5 per warrant “A warrants” which I’m primarily invested in. (I can explain more about warrants in a future post.)
Remember, the historical stock market average has hovered around 7%, so anything above that has historically beaten the market and up to 86% or more of active fund managers.
Plus, you don’t have to pay ridiculous fund administration fees to hold this one stock :).
#3. The company has a big margin of safety — and profit potential.
On top of the $1.50+ earnings per share the company can generate on an annual basis right now, the company’s accounting value is approximately $24 per share, and its tangible accounting value is $17 per share compared to a stock price around $16.50.
Simply put, the company’s stock price is less than the price accountants believe shareholders could get if the company closed up shop tomorrow. Obviously, it’s not going to close up shop while it is throwing off large amounts of cash in profit, so the fact that it’s trading at below its accounting and tangible accounting values is irrational to me — unless you believe the company will blow up, in which case I would love to see some evidence in the comments!
If the company just reaches its $24/share accounting value within two years by January 2019, that would equate to an approximately 45% return on the stock, or 120% return on the warrants. Say what?
Are there companies you’re excited about holding?
Background: I’ve had quite a bit of lucky history with the company, first investing in the stock in the midst of the financial crisis in 2009 at around $3.50/share, subsequently selling it around $12/share that same year, buying “A” warrants at around $3.50/warrant in 2011 and subsequently selling the warrants at around $6/warrant in 2012. I am currently long on “BAC A Warrants” again — as indicated in one of the screenshots above.