Bank of America Beats, Rallies 4%: Why I’m Still Buying (NYSE:BAC)

Bank of America Corporation (NYSE:BAC) just released its fiscal second quarter earnings. The release beat massively on earnings as well as on revenue. It showed a 14% increase in net interest income and a 29% net margin. On the whole, the release exceeded what analysts had expected by a wide margin.

Bank of America had a tough act to follow when it released earnings this morning. A few days prior, JPMorgan Chase (JPM) released its earnings, beating the revenue estimate by $2 billion and earnings by an equally wide margin. In light of this, Bank of America delivered a good performance. The earnings growth was not as strong as JPM’s, but that’s to be expected after the latter’s big First Republic take, which resulted in an immediate $0.91 gain in earnings per share. Overall, BAC’s posted numbers were satisfactory.

That’s not to say that there aren’t risks on the horizon. On the contrary, there are several. JPM CEO Jamie Dimon sounded somber when discussing the economy on his Friday earnings call, and BAC CEO Brian Moynihan also highlighted several risks on Bank of America’s earning call. Notably, the bank’s credit card charge-offs increased slightly in June.

Nevertheless, I remain bullish on Bank of America. The company’s second quarter numbers were very good, its liquidity situation remains strong, and it’s rapidly building up its cash pile to deal with any future increase in deposits. For this reason, I expect Bank of America to navigate any coming economic turbulence reasonably well, and to thrive if the economy avoids entering a recession.

Earnings Recap

In its second quarter earnings release, Bank of America delivered the following results:

• $25.2 billion in revenue, up 11% year-over-year (y/y).

• $14.2 billion in net interest income, up 25 %y/y.

• $9.2 billion in pre-tax pre-provision income, up 25 %y/y.

• $32.05 in book value per share, up 5 % y/y.

• $8.4 billion in net income, up 19% y/y.

• $0.88 in EPS, up 20%, beat by $0.04.

• $1.877 trillion in deposits down 7% y/y and down 1.5% q/q.

• $1.2 billion in investment banking fees, up 7%.

• An 11.6% CET1 ratio.

Overall, it was a pretty good showing. The results beat expectations and showed positive growth in investment banking fees, which had previously been declining. Additionally, in the financial supplement that came out with the earnings release, Bank of America revealed its balance sheet, which featured the following metrics:

• $1.877 trillion in deposits.

• $374 billion in cash.

• $143 billion in available for sale securities.

• $614 billion in held to maturity securities.

• $508 in held to maturity securities adjusted to fair value.

So, high-quality liquid assets were enough to cover 55% of total deposits, without considering expected monthly outflows. This is better than in previous quarters. Additionally, the liquidity coverage ratio was well above 100%, which suggests that the bank has more than enough liquidity to cover all the withdrawals it is likely to see in the run of a month.

Earnings in Context

It’s one thing to note that a company delivered a strong earnings release, but quite another to say that it will keep up the strong performance. Bank of America had many tailwinds in the quarter just reported, including high interest rates and a gain in deposits from regional banks failing in the 2023 banking crisis. Can it really keep up this strong performance?

If the people predicting an imminent recession are correct, then Bank of America’s performance would probably slowdown from here. Bank stocks tend to fall dramatically during recessions, and then rise dramatically afterward. The reason is that banks are cyclical. When the economy is growing, central banks tend to raise interest rates in order to fight inflation, while consumer spending and corporate spending tend to rise. Both factors (the higher rates and the rising spend) benefit banks. During recessions, central banks lower rates to get the economy moving again, and spending tends to fall. So, banks’ fundamentals are negatively impacted by recessions.

With that being said, I think that the consensus that we are about to enter a recession could be wrong. The yield curve has been inverted for a long time, but its predictive power is overrated. People often say that inverted yield curves predict recessions, but it can take up to 24 months for a recession to follow an inversion. Logically, if the yield curve inverts while the economy isn’t in a recession, then a recession has to follow at some point, because recessions are inevitable, a function of the business cycle. So, the fact that the yield curve is inverted right now does not mean a recession is imminent. Additionally, retail sales continue rising (though less than expected), and initial jobless claims keep falling. These do not look like harbingers of recession. It could be that we are at the very top of a business cycle, and a recession is coming in a few quarters. But it would take some time for the current economic momentum to slow down. I’d expect it to occur in early 2024 at the earliest.

So, interest rates are currently high, and the economy is doing well. Bank of America has a good foundation for continued earnings growth. One sticking point is the inverted yield curve itself. Banks borrow on the short end of the curve and lend on the long end. Theoretically, we should see their earnings fall when short-term interest rates rise above long-term rates. So far, we haven’t seen that happen. But the longer the inversion persists, the more Americans will become aware of the high interest rates available in treasuries, and the more banks will be pressured to meet treasury yields with their CD rates. This factor could eventually squeeze BAC’s interest margins.

Valuation

Having looked at Bank of America’s earnings and long-term outlook, it’s time to turn to its valuation.

At today’s prices, Bank of America trades at:

• 8.8 times earnings.

• 2.5 times sales.

• 0.93 times book value.

• 0.43 times operating cash flow.

Overall, it scores a “C” on valuation in Seeking Alpha Quant, making it about typical for a bank.

One thing worth noting about Bank of America’s valuation multiples: the book value multiple is based on reported equity, which in turn is based on reported assets. BAC’s equity is actually $109 billion lower than reported going by market prices of treasury securities. If you use the market values, then the price/book ratio rises to 1.2, which is still on the low end, although not so low that you are “trading a dollar for $1.075,” which the reported book value makes it appear to be.

The Bottom Line

The bottom line on Bank of America is this:

The bank’s post-earnings rally was well deserved. BAC beat on the top line as well as on the bottom line, revealed that its liquidity is still strong, and continued delivering the fat margins that investors have come to expect from it.

BAC’s earnings beat was not the widest of the current big bank earnings season – that honor goes to JPM – but it moved the stock’s price more than any other. That’s perhaps a reflection of just how pessimistic investors were about BAC going into the release. The bank got a lot of bad publicity about its unrealized losses during the spring banking crisis, but as the Q2 release showed, liquidity is still strong despite the losses.

So, I still consider Bank of America stock a buy. I consider it a buy up until about $34, at which level the P/E ratio rises to 10. Obviously, much of the good news is being priced in with today’s rally, but still, BAC is cheaper than many other banks while being of comparable quality. You can’t go back in time to March 2023, buy the stock, and lock in quick gains, but you can still to this day enjoy an above-average dividend.