Cash In On Bank of America

As each day goes by, one investment pundit after another touts the attractive valuation of Bank of America (NYSE:BAC). Most notably, Morningstar Fund Manager of the Decade Bruce Berkowitz is a big fan. His Fairholme Fund has a 5% position in BofA. Yet as each day goes by, shares in BofA continue to slide. Year to date, BofA shares are down nearly 45% while the broad market is down just over 7.5%.

TUTORIAL: The Industry Handbook: The Banking Industry

Patience Pays
Looking at BofA today, it's fair to say the company still has its issues to work through. But the company is working through them and the market doesn't care about that. Shares in BofA now trade for just under $7, or a market cap of $70 billion. Although the company reported losses in its most recent quarter, that was as a result of huge settlement losses relating to its crop of bad mortgages assumed when Countrywide Financial was acquired. The banks core operations are actually doing quite well and on track to earn $1 a share in 2011. Of course, those profits will be eaten up by mortgage and litigation charges in 2011.

The key to successfully investing in BofA or any financial company in distress is patience. BofA assumed a boat load of loans that were underwritten at the peak. But today's loans are of very high quality. Over the next several years, as the bad loans whittle down and the good loans take over, the bank's real earnings power should begin to reveal itself. This won't happen quickly and without hiccups. (For related reading, see What Is The World Bank?)

A Solid Franchise
Today, BofA serves approximately one out of every two American households with over $1 trillion in customer deposits. Through its various acquisitions over the past couple of years, the company is now a top tier player not only in retail banking, but private wealth management and investment banking. With over $2.2 trillion in assets, a reasonable expectation of a return on assets of 1% in 2013 would equate to $22 billion in net income. At a current market cap of close to $70 billion, BofA trades at less than four times those implied earnings. Even if ROA was 0.5%, the company is potentially being valued at about 7 times earnings. Widely considered one of the better run banks, Wells Fargo (NYSE:WFC) trades at a little over nine times earnings today and it currently generates a 1% ROA. That same nine-times multiple would put BofA shares north of $19 based on a 1% ROA in 2013 and $22 billion in net income.

While the uncertainty around some of BofA's assets leaves many investors less reliant on book value, it is still a useful metric with respect to financial companies. With a market cap of close to $70 billion BofA now trades at nearly a 50% discount to tangible book value of $147 billion. Total equity stands at $231 billion as of last quarter, but tangible equity is a more reliable metric as it eliminates all intangible and goodwill assets. That's the biggest discount to tangible book amongst all major financial stocks including other underperforming names like Citigroup (NYSE:C) and AIG (NYSE:AIG).

The Bottom Line
Bank of America is not without its problems. But under the helm of CEO Moynihan, the company is working quickly to address and resolve its issues. As those issues get resolved, the earnings of the core business will start to grab the attention of Mr. Market, who will almost certainly be quick to send shares higher. (For related reading, see What Are Central Banks?)

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