There are a few times in the life of an investor when the stars align and you find a trade that you’re confident will earn nice return. I’m 38 years old, and I’ve been investing since I was 18. This trade is only the second time in my life that I feel I found an investment that will easily outperform the S&P 500 over next several years.
Bank of America (NYSE:BAC) is positioned very well for 2017 and beyond. Below I outline seven reasons why this stock is a good buy heading into the new year.
#1. Valuation
Bank of America’s stock price has traded below its book value since the financial crisis. This is not surprising as the big banks have been unpopular since 2008, but that has changed recently.
Despite the recent surge in prices, this stock still looks cheap. Its current price-to-book-value is around 0.90. Meanwhile it traded at two times book value before the crisis, and it’s common for banks to trade at two times book during normal times.
Investors have already started to cycle money back into bank stocks. As this trend continues, expect this stock’s to price-to-book-value to rise along with its other ratios.
#2. Buybacks
The bank has been buying back its shares for a couple of years. Additionally, Bank of America plans to continue their buyback program by purchasing an additional $5 billion worth of shares over the next 12 months starting in 3Q16.
A buyback can increase a stock’s price in several ways:
First it signals to the market that a company thinks its shares are undervalued. As no one knows more about a company than the insiders making the decision to repurchase shares, this is strong indicator that the stock is cheap.
Second the repurchasing company becomes a major buyer of its stock. This gives price support that wouldn’t exist without the buyback.
Third a company rarely trades its stock once repurchased. These shares are basically off the market. Per microeconomics, prices increase as supply decreases and demand remains the same. Buybacks effectively decrease the supply of stock.
#3. Dividends
In addition to their buyback program, Bank of America recently increased dividends by 50% and plans to pay $3 billion in dividend payments over the next year. An increase in dividends not only provides investors with additional cash flow, but it signals that management is confident with its financial position and business plan.
#4. Interest rates
Interest rates are increasing. As rates rise, banks earn more interest from loans. This is significant as about 50% of Bank of America’s revenue is driven by interest income.
Just last quarter, the bank projected that a 1% increase in rates would generate an additional $5.3 billion in income. Wall Street expects the Fed to increase rates a few times in 2017.
#5. Cost Cutting
Bank of America plans to continue cutting costs. This will have a positive impact to its bottom line. The bank is forecasting about $3 billion reduction in costs by 2018.
These savings coupled with higher earnings driven by interest rates will have a positive effect on the bank’s earnings. Higher earnings often lead to higher share prices.
#6. Deregulation
A couple of days after Donald Trump was elected, his transition team announced that it plans to “dismantle the Dodd-Frank Act”. Even if they are not able to completely repeal this legislation, any change would most likely benefit the banks. These changes could allow banks to hold less capital and reduce compliance costs which would lead to higher earnings. These earnings increases could be large and lead to a significant increase in share price.
#7. Corporate Taxes
President-elect Trump plans to lower the corporate income tax rate from its current level of 35% to 15%. Bank of America’s current corporate tax rate is about 30% after deductions. A decrease would benefit the bank’s net income and return-on-equity which again could lead to a higher share price.
Conclusion
There are number of tailwinds that will continue to propel Bank of America’s share price in 2017. It’s low valuation, company actions to improve investor returns, the interest rate environment, and the political environment all currently favor this company.
So many factors will continue to push this stock higher, that even after the great run it had over the last couple of months, Bank of America is still a good buy heading into the new year.
Disclosure
I’m long Bank of America.