Here's Why Bank of America Is Still Undervalued

Guest Author |

While Fed starts tapering, the interest rate is likely to go up sometime in the near future. In the meantime, Bank of America's (BAC) interest margins are going up and non-interest income from fees are increasing, which will push up its revenue and potentially have a positive influence on its stock price. There are also some other factors that when we take into consideration, we can find out that BAC is undervalued right now and its stock price is very likely to pick up soon.

The following graphs and data are extracted from Thinknum, which gave us some quite straight forward ways of analyzing the company performance.

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The short volume is again almost the lowest within the last five years, meaning that most of the investors are relatively optimistic about the company. The short ratio right now is only 0.9, which is extremely low.

 

The debt to equity value since 2010 has been decreasing at a steady rate. While the equity value of the stock is definitely going up, the number of debt since the financial crisis is also on a downward trend, showing that the company is maintaining a healthy business and keeps paying off the debt.

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After several years of decreasing cashflow interest coverage, the company finally generates sufficient cash in 2013 to pay off its interest expense. This momentum is likely to continue in 2014.   

 

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Bank of America and Citi are the only two banks now with Price to Book value less than 1. This ratio basically means that we can buy BAC stock with less than its book value, again proving that the stock is very very cheap.

Lastly, we could use a simple dividend discount model and multiple comparison model to estimate its stock price.

Valuation using multiples:

The P/E ratio for Bank of America’s competitors is

Citi: 11.42

UBS: 23.94

Deutsche Bank: 40.06

HSBC: 12.44

JP Morgan: 13.66

The average of these numbers is 20.304, and while we know that the diluted EPS for Bank of America right now is 0.9, the appropriate stock price should be 20.304*0.9=$18.27.

As for DDM, we assume that the reinvestment just earn the cost of capital, meaning that re is same as ROE. Therefore:

 

BAC_Formula.png

While the present dividend D0 is $0.05 per share, and EPS0 is $0.9, so the reinvestment rate is (0.9-0.04)/0.9=95.6%, while the return on equity ROE is 5.24%, the long term growth rate g = 95.6%*5.24% = 5.01%

Therefore, the expected Earning per Share next year EPS1 is 0.9*(1+5.01%) = 0.945.

So the stock price P =  EPS1ROE = 0.9455.24% = $18.04.

By taking the average of Multiples valuation and DDM valuation, we have the estimated stock price P = (18.27+18.04)/2 = $18.15, which is a 20% premium of the present stock price. It is definitely not a large number, but at least it shows that the stock is undervalued right now, which is in accordance with the factors mentioned.

All in all, I believe that Bank of America is a company worth investing with undervalued stock. While the Oracle of Omaha also holds a bunch of warrants that allowed him to buy 700million BOA shares before 2020, hopefully this should give investors some confidence about the stock.

By Zusheng Huang. Zusheng is a first year financial engineering student at the University of Michigan.

 

 

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
HSBC HSBC Holdings plc. 41.17 -0.26 -0.63 1,864,205 Trade
JPM JP Morgan Chase 87.00 -0.61 -0.70 10,755,629 Trade
DB Deutsche Bank AG 18.07 -0.08 -0.44 6,605,679 Trade
BAC Bank of America Corporation 23.34 -0.31 -1.31 69,384,908 Trade
UBS UBS Group AG Registered 17.01 0.28 1.67 3,442,246 Trade
CGPI China Redstone Group Inc 0.00 0.00 0.00 0

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