Bank of America is the second biggest bank in America by assets and the third largest by market cap. Nevertheless, multiple factors have contributed to Bank of America becoming extraordinarily undervalued in comparison to both current market levels and its past valuations.
Litigation Issues (And Why They Really Don’t Matter)
The most recent plague to hit Bank of America are the litigation issues with the DOJ (Department of Justice). The company is being forced to give billions in cash to the government in order to make up for the mortgage issues that caused the crash of 2008 and the near-bankrupcy of the company. The current negotiations are standing at $17 billion in payments to the DOJ, with $9 billion in cash and rest to be paid later on. To put into perspective as to how much money that truly is, last year’s annual net income for the company was only a meager $10 billion, nowhere near enough to cover the payment to the DOJ. So where’s Bank of America supposed to get the money to pay the government? In its massive cash hoard. In an effort to not have a global crisis like 2008 again, the government is requiring banks to hold extreme amount of capital on hand instead of loaning it out to consumers. They then check the banks through an annual “stress test”, simulating a financial crisis similar to 2008 and seeing if the banks have the necessary capital to survive those kinds of recessions. Bank of America has well over enough money to pay back the DOJ in its cash pile, which sits at an incredible $524 billion. Unfortunately for investors, Bank of America cannot spend this money on operations, as it is not truly “their” money. Nevertheless, Bank of America has ample time to earn back the money they owe to the DOJ and get one of the largest settlements of all time off of its shoulders. The bank currently has minimal negative headwinds and should grow without hinderance in the future.
The Merrill Lynch Accounting Issue (And Why it Doesn’t Matter Either)
Bank of America, in the most recent release of their total capital for the government stress test, apparently overstated their total reserves in Merrill Lynch by $4 billion. Since the Federal Reserve now has to approve of all captial plans by banks, such as buybacks and dividends since many banks were too slow to cut their dividends in 2008 and further contributed to the overall decline, Bank of America had to resubmit their capital plan to the Federal Reserve, this time only asking for a dividend increase instead of a share buyback plan as well (which they already had approved before). Investors overreacted to this declaration and the stock is still nowhere near the highs they had before this issue was found and made public, but the Federal Reserve has already approved a dividend increase, but no share buyback. Long-term investors in the company shouldn’t mind this minor mistake by management, as their is not lasting effect on the company from this action. Unless you count a minor share buyback plan that would only reduce shares outstanding by 3%. I am confident in management’s ability to continue growing the company and I believe that by the next year they will have the neccesary capital to recieve both a dividend increase and a share buyback program.
Current Undervaluation (P/B Ratio)
The recent article on AIG showed that it was undervalued by 23% based on the price to book value. In short, this means that, when all the liabilities are subtracted from all the assets of the company, you come up with a figure 23% above the market cap of the company, so you can essentially buy every dollar the company owns for 72 cents. Incredibly, Bank of America is undervalued by the exact same amount as AIG, and the undervaluation probably stems from the same fact of both companies: that they nearly went bankrupt in 2008 and investors are still fearful of them. Us, as intelligent investors, can take advantage of this fear and be greedy, as Warren Buffett would put it, and profit off buying an undervalued company that others are too fearful to touch.
Bank of America is an extreamly undervalued company that seems to be being beaten down from every single direction right now. None of the current issues affect the long-term health and future of the company, however, and should be taken as a buying oppurtunity for when the company’s true value is found.
Stock Investing Advisor 