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If you're thinking about investing inBank of America today, I've got some bad news for you: You're probably too late.
Values, trading, and investing
In the book You Can Be a Stock Market Genius, value investor Joel Greenblatt explains the difference between trading and investing.
A trade is when you buy a company because the market has mispriced it -- the stock is cheap. Investing happens when you buy a company because its price is reasonable (or cheap), but it's such an amazing business that the underlying stock price seems bound to appreciate.
Trades are shorter term. Investments are longer term.
I bring this up because it directly applies to potential Bank of America stock purchases today. In my view, the nation's second biggest bank by assets isn't priced cheaply enough for a trade, and it's just not of sufficient quality to justify an investment.
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Bank of America's valuation, then and now
In January 2012,Bank of Americatraded at just 0.25 times book value. That means you could buy the company at 25 cents on the dollar -- that is, assuming you believed the bank's assets were worth as much as the accountants said they were.
Even so, 0.25 times book value is ridiculously cheap. Generally speaking, a bank that trades with a price-to-book below 1 is cheap. A P/B ratio above 2 is usually considered expensive.
Some savvy investors saw the Charlotte, N.C.-based megabank at these prices and pounced. Their timing has been rewarded, with the stock rising 184% from January 2012 to today.
But that price appreciation has changed the bank's prevailing price-to-book value. Today, Bank of America trades at 0.75 times book value. Still below 1, but not cheap enough if you ask me.
Consider another megabankJPMorgan Chase . It currently trades at1.1 times book value -- while pricier than Bank of America, that's certainly not a huge premium.
What does this premium buy you? Based on the banks' fourth-quarter 2014 results, it buys you 58% more profits. JPMorgan is also both larger than Bank of America and considerably better run. It's no coincidence, for instance, that the government went to JPMorgan during the financial crisis to purchase not one, but two, major financial firms to save them from careening into bankruptcy.
What about buying Bank of America as an investment?
My criteria for a bank stock investment is pretty straightforward. A bank must be efficient. It must have a history of successfully managing credit risk through the ups and the downs of the credit cycle. It needs to produce a strong return on assets. The management team needs to exude risk management in every conference call, every annual report, and every investor presentation.
Bank of America, in my assessment, falls short on all accounts.
Using data provided by S&P Capital IQ, the bank's efficiency ratio for the fourth quarter was a lackluster 74.9%. Return on assets on a trailing-12-month basis is just 0.2%. The bank has repeatedly failed to demonstrate credit discipline through the past 25 years of economic cycles. And while other banks are increasing loan reserves for the next turn in the cycle, Bank of America is moving forward with reserve releases.
Yes, it is certainly possible that CEO Brian Moynihan will successfully transform the bank's culture and lead Bank of America into the elite sphere of U.S. banks. For the sake of the bank's shareholders and customers, I hope he does. But for potential investors today, the bank is simply not up to snuff. It's not cheap enough to trade, and it doesn't have the special sauce to justify a long-term investment.
The article If You Buy Bank of America Today, You're Already Too Late originally appeared on Fool.com.
Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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