There's a lot to like about Bank of America's (NYSE: BAC) stock right now, but that doesn't necessarily mean it's a buy in July. While the bank's earnings continue to improve, its share price seems to have gotten ahead of the fundamentals.
Bank of America's latest quarterly performance is emblematic of its ongoing recovery from the financial crisis. It earned $4.4 billion for common shareholders. That was up from $4.3 billion in the previous quarter, and it was way up from the $3 billion it earned in the first quarter of last year.
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Bank of America still isn't where it wants to be in terms of profitability, but it's getting there. Its main target is a 12% return on tangible common equity. This is above the 10.3% it earned in the first quarter, but if Bank of America continues on its current trajectory, then it could meet that target on an annualized basis by the end of this year, as I discussed here.
On top of this, interest rates are trending in the right direction, which is important for bank earnings. The Federal Reserve has increased the benchmark short-term rate, the fed funds rate, three times since last December. Higher rates translate into higher loan yields and thus more net interest income. The Fed's rate hike in March, for instance, is expected to boost Bank of America's top line by $150 million a quarter, holding all else equal.
Bank of America's shares also seem to be reasonably priced. Its stock trades for 13.7 times its projected earnings over the next 12 months. Meanwhile, the average bank on the KBW Bank Index, which tracks two down large-cap bank stocks, trades for 15.8 times earnings over the next 12 months. And the same holds true when you look at stocks more broadly, as the average stock on the S&P 500 trades for 23.9 times forward earnings.
What's important to keep in mind, however, is that there's a reason Bank of America's stock trades at a relative discount. Because the North Carolina-based bank already holds more than 10% of the nation's deposits, it's legally prohibited from buying other banks. This closes off one of two ways for it to grow, putting Bank of America at a disadvantage relative to rapidly growing banks such as Pinnacle Financial Partners and Bank of the Ozarks, two of the best-performing bank stocks over the past two decades.
Moreover, Bank of America is subject to stricter regulatory supervision than most other banks are.
- Unlike banks with less than $10 billion in assets, Bank of America falls under the jurisdiction of the Consumer Financial Protection Bureau and must also abide by the Durbin Amendment to the Dodd-Frank Act, which constrains how much it earns from interchange income -- fees incurred each time a bank's customers use their credit or debit cards.
- Unlike banks with less than $50 billion in assets, Bank of America must participate in the annual stress tests, the results of which were recently released for this year's test.
- And unlike all but seven other major banks, Bank of America is subject to higher capital and liquidity requirements as a result of being classified as a global systemically important bank, or GSIB.
Finally, while Bank of America's shares understandably rallied in the wake of the presidential election, on hopes that the new administration will lower corporate income taxes and ease the regulatory burden on banks, it seems reasonable to wonder whether those gains are sustainable given the struggle to get legislation on these issues through Congress. The stalled attempts to repeal and replace the Affordable Care Act serve as a case in point.
The net result is that, while Bank of America's fundamentals are getting better, it's far from clear that this is a good time to buy its stock. To this end, given the run-up in bank stocks since the election, I believe that investors have more to gain than to lose at the moment by waiting for a pullback in the market before delving further into shares of Bank of America.
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