How Bank of America Gets to $30
Assuming the past five years are an aberration, and not simply a magnified version of business as usual, then it isn't unreasonable to believe that Bank of America could get to $30 a share at some point in the not-too-distant future.
I don't say this naively. While I believe the Charlotte, N.C.-based lender will eventually turn things around, I'm well aware of the obstacles in its path. Over the last year, I've meticulously documented Bank of America's pending and completed legal settlements. The picture that emerges isn't one of a disciplined and reputable organization.
It nevertheless seems ignorant to conclude that things won't eventually turn around for the bank. At some point, it will have atoned for its past indiscretions. And at some point, interest rates will head higher and fuel Bank of America's top and bottom lines.
It's with this in mind that I created the following matrix, which estimates Bank of America's hypothetical share price under different combinations of profitability (measured by return on assets) and valuation (measure by the price-to-earnings ratio). As one would expect, the share price increases as one moves from top to bottom, as its price-to-earnings ratio increases, and from left to right, as profitability improves.
Where can shareholders expect these figures to settle over the long run? While it's impossible to forecast this with precision, we do know that in the 15 years before the crisis, Bank of America's average price-to-earnings ratio came in at 12.1 while its average return on assets was 1.39%. And it's by rounding those down and projecting them forward that one arrives at a price of $30.66.
Now, it's probably safe to assume that both of these historical figures are out of reach for Bank of America going forward -- at least on a sustainable basis. Not only is the bank larger, which increases the challenge of earning high returns, but it's also operating under a different set of economic and regulatory constraints. Gone are the days that it can exploit customers with impunity. And gone are the days, at least for now, in which rising home prices laundered irresponsible underwriting.
But an important countervailing force will be Bank of America's success at returning capital to shareholders, and specifically by way of a responsible repurchase program. This will decrease the bank's outstanding share count and thereby boost the earnings attributable to each unit. The net result will be a higher share price despite a potentially lower price-to-earnings multiple -- this is ignoring future dilution from Berkshire Hathaway's warrants.
The point is simply that, barring a prolonged period economic malaise akin to Japan since the 1990s, it seems realistic to believe that Bank of America's stock will once again crest the $30 threshold. For investors, in turn, the unknowable question is whether it will beat or lag the market in the process of doing so.
Bank of America's terrifying and profitable competition
Amazingly, despite its rapid growth, this bank is still flying under Wall Street's radar. To learn about about this company, click here to access our new special free report.
The article How Bank of America Gets to $30 originally appeared on Fool.com.John Maxfield has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.