Despite Interest Rate Headwinds, Bank of America Stock Is Still A Good Investment

After more than a 60% gain since the March 23 lows of this year, at the current price of $30 per share we believe Bank of America Stock (NYSE: BAC) has some more room for growth. Bank of America, one of the top five banks in the U.S., has seen its stock rally from $18 to $30 off the recent bottom compared to the S&P which moved around 65% – the stock is slightly behind the broader markets and is still down 15% YTD. It could be attributed to lower than expected Q3 revenues and a drop in net interest income due to a lower interest rate environment – cumulative nine months revenues of $65.4 billion were 5% below the year-ago period, mainly driven by a 10% drop in net interest income. Further, the provision for credit losses increased to $11.3 billion for the nine months as compared to $2.6 billion in the year-ago period, mainly due to the higher risk of loan defaults on outstanding loans.

Bank of America’s stock has partially reached the level it was at before the drop in February due to the coronavirus outbreak becoming a pandemic. Despite the rise since the March 23 lows, we feel that the company’s stock still has potential as its historic P/E multiple implies it has further to go.

The company’s revenues hovered around the $91.2 billion mark over 2018-2019, however, the net income figure decreased by 3% over the same period. This was mainly due to a slight drop in the net income margin from 30.8% in 2018 to 30.1% in 2019.

While the company has seen stagnant growth in revenue over 2018-2019, its P/E multiple has increased. We believe the stock is likely to see some upside despite the recent rally and the potential weakness from a recession-driven by the Covid outbreak. Our dashboard “What Factors Drove 22% Change In Bank of America Stock Between 2018-End And Now?” has the underlying numbers.

Bank of America’s P/E multiple has changed from just above 9x in FY 2018 to around 13x in FY 2019. The company’s P/E has suffered from a drop in Q2 and Q3 revenues and is just below 11x now. This leaves some scope for upside when the current P/E is compared to levels seen in the past years – P/E multiple of around 13x at the end of 2019.

So Where Is The Stock Headed?

Bank of America is very sensitive to a drop in interest rates given the bank’s sizable deposit and loan portfolio. Hence, the zero rate policy by the Federal Reserve in response to the Covid-19 crisis is likely to pressure the bank’s net interest income. Further, as the economy moves toward normalcy, the higher trading revenues due to a jump in market activity are expected to normalize in the coming months. Overall, Bank of America’s revenues are unlikely to see an immediate recovery in the near term. That said, as the economic condition improves, the loan repayment capability of businesses and retail customers are likely to recover, resulting in a favorable decrease in provisions for credit losses. Additionally, the bank is expected to start its share repurchase program in 2021. Both these factors are likely to have a positive impact on Bank of America’s profitability and earnings, providing a boost to its stock price.

The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Following the Fed stimulus — which set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view. With investors focusing their attention on 2021 results, the valuations become important in finding value. Though market sentiment can be fickle, and evidence of an uptick in new cases could spook investors once again.  

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