Bank of America Shows Me the Money!

Next week the folio ka-chings! No, not the way you thought. The worst-known manager has picked Bank of America (BAC) to carry the banner for financials. For a long time I wanted to play financials with an Investment Banking stock. I was wary of the commercial (or consumer) banking sector because of its susceptibility to a flat or inverted yield curve, which makes banks’ borrowing costs higher than their lending costs.

However, I-banking stocks tend to behave like growth stocks and generally have higher Betas than their commercial banking counterparts. The folio is really growth-biased but I feel like a very low Beta (volatility) stock is needed to give it some balance.

Furthermore, since the folio is going to have direct exposure to only one US financial stock – the folio is indirectly exposed to foreign banks through EFA and EEM – it might as well be an “integrated” bank, which combines I-banking with commercial banking.

So an integrated bank it is. Okay, but then why not Citigroup (C) or JPMorgan Chase (JPM), BAC's erstwhile competitors? As a long-term investor I’ve used some of my most favorite fundamental metrics to rank C, BAC, and JPM – actual data points can be found at Yahoo Finance. Check this out:

Metric	Citi	Bank of Am	JPM Chase
Profitability
Profit Margin	2	1	3
Operating Margin	2	1	3
Management Efficiency
Return on Equity(ROE)	1	2	3
Growth
Quarterly Revenue Growth	3	1	2
Quarterly Earnings Growth	3	1	2
Balance Sheet
Total Cash	1	3	2
Total Debt	3	2	1
Cash Flow
Operating Cash Flow	1	2	3
Dividends
5-yr Avg Div Yield	3	2	1
Payout Ratio	2	1	3
Forward Annual Div Yield	2	1	3
Stock Volatility
Current Beta	0.42	0.47	0.67

I suspect the reason BAC is not top billing in ROE is its small global exposure. In 2005 it earned about 7% of revenue from overseas operations, compared to C (67%) and JPM (21%).

Now, I’ve examined BAC’s annual reports for the past three years – with particular attention paid to the Chairman’s letters, gleaned news archives and studied analyst reports that I can lay my hands on. There is no doubt that BAC plans to go global in a big way soon. En fait, it has to go global if it really wants to grow big. Right now, it is pushing against the regulatory ceiling for its core consumer banking business in the US.

BAC is well known for its generosity when it comes to dividends, but I decided to get into the stock really because of its growth potential and long-term performance. When you look on a global scale at where BAC is missing in action, Europe Middle East and Africa (EMEA) just jumps out at you. There is no smoke without fire and the recent rumor about a possible acquisition in Europe is not without merit. Bank of Am is on a treasure hunt in Europe; period.

In terms of performance over the long-term BAC has trumped C and JPM in stock appreciation on a trailing five-year basis. Not bad for a stock more known for being a dividend cash-cow. This historical feat is certainly no guarantee of future performance but here’s the real kicker about this stock going forward: I may not be a sucker for dividend income right now but baby boomers (1946-64) are.

When boomers start to draw income as they retire over the next few decades – there goes social security – stocks like BAC will be top of their list. I can’t think of any demographic change with the potential to benefit cash-cow stocks like BAC as the retirement of boomers. The demand for BAC stock is clearly going to do wonders for its appreciation.

On the balance sheet front, BAC’s smaller cash position compared to the other two banks doesn’t bother me as much as the huge debt. However, since the bank is numero uno in US deposits and a top-five wealth manager this makes sense.

Bearing in mind my aversion to the vulnerability of commercial banking to compressing net interest margins I take comfort in the fact that BAC’s revenue base is the least weighted in commercial banking - at 51%, compared to C (59%) and JPM (54%). My feeling is that BAC aims for a majority non-commercial banking revenue base, based on the growth rates of the firm's individual businesses. I certainly hope so.

In terms of growth expectations integrated banking stocks are fairly valued right now but are cheap compared to the overall financial sector. On a forward price/earning (P/E) basis, BAC is the cheapest of the three banks and the pull-back on Friday was an opportunity to buy a solid financial stock that is going places.

It was definitely a close call between Bank of Am and Citi. In the end, however, the long-term growth prospects for BAC did it for me.

So there it is. The financial stock vacancy in the folio has been filled. Next stop. Africa, the motherland!