Believe it or not, in this market it's hard to find undervalued stocks that are at their cheapest in years. That doesn't mean there aren't good deals to be found; but it may be a stretch to call many of these stocks undervalued.
The S&P 500 is up nearly 8% year to date, and many of the market's top stocks are on the rise. They're not quite as cheap as they were at the height of the bear market, even if they still present attractive entry points. Other stocks, specifically the high-growth stocks that were market darlings in the previous bull market, look incredibly cheap -- but it's hard to call them undervalued when they're posting net losses and growth rates are slowing down.
There is one industry, however, where stocks may be both cheap and undervalued, and that's the banking industry. Even the most stable banks were hit hard by the liquidity crisis earlier this year, and although their stocks have recovered to some degree, some of them are still trading at their lowest prices in years. Warren Buffett-favorite Bank of America (BAC -0.96%) is down 10% this year, even as many of its peers are showing gains. Shares trade at only 1.3 times tangible book value, a sizable amount less than its five-year average of 1.6, and 9 times trailing-12-month earnings, well below the five-year average of almost 13.
Let's see why more than being cheap, Bank of America shares look undervalued, and why they present a buying opportunity.
High performance in a challenging environment
Altogether, BofA's first quarter was solid. Revenue increased 13% year over year to $26.3 billion, and earnings per share rose 15% to $0.94, both beating Wall Street's expectations. Net interest income was a standout, increasing 25% to $2.9 billion, driven by both higher interest rates and growth in loans. BofA also eked out a 1% increase in non-interest income, driven by higher sales and trading revenue, more than offsetting lower fees.
The main fallout from the high interest rate environment was the decline in deposits, which were down $20 billion, or 1%, to $1.9 trillion. Specifically in the consumer banking division, which is BofA's bread and butter, average deposits decreased 3% from last year, or $30 billion.
Image source: Bank of America.
BofA wasn't severely impacted by the banking crisis, which involved nervous account holders withdrawing money at a clip too rapid for some banks to cover. The banks that ended up failing were holding long-term bonds they didn't want to sell because at current prices they would be taken as losses, and the money came out too quickly for management to change its tune.
BofA also holds these kinds of bonds on its books, but it wasn't forced to sell them since account holders didn't pull out more than it could comfortably cover. That's one of the advantages of being a large, reputable bank with many account streams.
At the same time, BofA did set aside $901 million in provisions for losses for a total of $931 million. Net charge-offs increased from $392 million last year to $807 million this year.
Why is Wall Street so down on BofA?
Despite the earnings beat and altogether solid quarter, Wall Street is still pessimistic. BofA is more consumer-facing than some of its larger peers, which gives it greater exposure to the credit problems that caused the banking fiasco and took some banks under. That was underscored by the decreased deposits in the quarter.
However, it also benefited from increased account holders in the consumer banking division, likely fueled by other bank collapses or near-collapses.
Long term, Bank of America is well positioned to retain its strong credit quality and create shareholder wealth, and investors can see the lower price as an opportunity to buy shares of this value stock.
