If analysts are right, then Bank of America should earn $1.57 per share next year, which equates to a 9% increase over expected full-year 2015 earnings. This sounds great, but there's more to it than meets the eye.
The issue when you're talking about stocks is less about earnings per share and more about profitability.
Continue Reading Below
Let's assume that Bank A earns $20 per share and Bank B earns $10 per share. At first glance, it seems like Bank A is the better investment, as its earnings per share is twice that of Bank B. But if Bank B's shares cost $100 compared to Bank A's $250 share price, then Bank B's earnings yield, which measures profitability, equates to 10% ($10/$100) compared to Bank A's 8% ($20/$250). Thus, even though Bank A earns more per share, an investor would get more bang from their buck, so to speak, investing in Bank B.
When you distinguish between profits and profitability, you get a different view of Bank of America's expected earnings next year. You can see this by comparing the $2.15 trillion bank's projected 2015 profitability against its projected 2016 profitability:
- This year, Bank of America is expected to earn $1.44 per share. If you divide that by its tangible book value per share, its return on tangible common equity is 9.4%.
- Conversely, Bank of America is expected to earn $1.57 per share next year. If you assume its tangible book value per share continues to climb at an average rate of 2.4% per quarter (sequentially), which it has done over the last four quarters, then its return on tangible common equity would equate to only 9.3% -- this assumes that Bank of America's average diluted shares outstanding stays constant (which it won't, but it's impossible to predict with certainty if outstanding shares will increase or decrease by the end of 2016).
Bank of America's problem is that it generates less revenue than its competitors do, after adjusting for the size of their respective balance sheets. For the first nine months of 2015, for instance, Wells Fargo reported $64.5 billion in net revenue (i.e., total revenue less interest expense) compared to Bank of America's $64 billion. This seems like a close call until you consider that Wells Fargo generated more net revenue with $168 billion in tangible shareholders' equity than Bank of America did with $182 billion worth of tangible capital.
Higher interest rates will help Bank of America, as it expects to earn $4.5 billion more a year in net interest income (and thus net revenue) if short- and long-term rates rise by 100 basis points, or 1 percentage point. But even then, Bank of America would still lag Wells Fargo, which is also primed to benefit from raising rates.
For Bank of America to close the gap, it needs to sell more products, write more loans, open more fee-generating accounts, attract more investment banking business, and increase the assets overseen by its wealth management division. And it needs to do so at a faster pace than Wells Fargo, which is easier said than done when you consider that one of Wells Fargo's strengths is its high cross-sell rate.
The good news is that Bank of America's focus has shifted over the past 12 months. Prior to that, the Charlotte, North Carolina-based bank was focused primarily on reducing operating expenses and slaying outstanding legal liabilities. With both of those now seemingly under control, it has begun to invest in potential growth drivers. To this end, while Bank of America's total head count has fallen by 11,614 in its consumer banking division over the past two years, the number of sales specialists in its branches has increased by 197, or 2.8%. That's a small start, but it's a start nonetheless.
In sum, assuming analysts are right about Bank of America's prospects next year -- which isn't a foregone conclusion -- then the nation's second biggest bank by assets seems poised to disappoint investors in terms of 2016 profitability, even though its profits per share are expected to rise.
The article How Much Do Analysts Expect Bank of America to Earn in 2016? originally appeared on Fool.com.
John Maxfield has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short January 2016 $52 puts on Wells Fargo. The Motley Fool recommends Bank of America. 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.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.