To The Moon

Summary

• I view Bank of America currently as a momentum stock, especially after its Q2 earnings report.

• It has attracted the highest trading volume on the open market among banking stocks.

• Such activities are in stark contrast to its insider activities (or the lack of buying activities).

• I will explain why I agree with the insiders and see other better alternatives.

Bank Of America"s Earning Exceed Analysts" Expectations

Brandon Bell

Thesis

Bank stocks have drawn a lot of attention recently. First, the SVB sell-off in the first quarter of this year triggered high selling pressure. Then the recent Q2 earning season reversed course and created a good amount of buying pressure. Amid all this attention, Bank of America Corporation (NYSE:BAC $Bank of America(BAC)$ ) managed to stand out and attract the highest trading volume on the open market among banking stocks. According to data from Google Finance (shown in the chart below), BAC was the most traded banking stock in the S&P 500 using the data of last week, the week of July 16, 2023, and also the week when it released its Q2 earnings report (“ER”). With an average volume of 43.08 million shares and a total volume of 1.29 billion shares, BAC was ranked top 1 on the list, followed by Citigroup Inc. (C) and JPMorgan Chase & Co. (JPM).

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Source: Author based on Google Finance data

There are certainly good reasons to be excited about BAC. In its Q2 ER, the bank just reported one of the best quarters in its history amid macroeconomic turbulence like the debt ceiling and monetary tightening. To wit, its EPS dialed in at $0.88, a whopping 21% increase YOY. It also reported improving operating leverage for the 8th consecutive quarter. What is more important in my view are two specifics its CEO Brian Moynihan mentioned during the ER. First, he noted that the overall economy is renormalizing to the pre-pandemic conditions in the following comments:

As you look at it now, our customer spending patterns now are more consistent with the pre-pandemic, lower growth, lower inflation economy.

And second, he noted the strengthened balance sheet (see the chart below). A few highlights include the improved common equity Tier 1 ratio and ample liquidity. To wit, its Tier 1 ratio improved by more than 110 basis points YOY and currently stands at 11.6%. And the bank also sits on $867 billion in Global Liquidity Sources.

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Source: BOA 2023 Q2 ER

Based on the robust fundamentals, the stock enjoyed a sharp price rally after the ER as highlighted in the next chart below. Combined with the large trading volume just mentioned, I view the stock as a textbook example of a momentum stock now.

As such, the goal of this article is to examine the ongoing market hype and point out a few counterarguments for long-term buy-and-holder investors. I will start with an analysis of its insider activities. As you will see next, the insiders’ activities (or the lack of them) are in stark contrast to the hyperactivity in the open market. And furthermore, all the insider activities have been selling activities. Ultimately, insiders know more about the true value of their own bank. In the remainder of this article, I will first detail the insider activities. I will then explain why I agree with the insiders' selling decisions and see better alternative banking stocks.

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Source: stockcharts.com

BAC’s lack of insider buying

In the past year, there have been only a total of 3 insider transactions as shown in the chart below. And all the 3 activities were selling activities. More specifically, the presidents of three different divisions disclosed three sizable sales totaling more than $13 million. And all selling activities were in the price range of ~$31 to $35, which is quite close to its current market price. Next, I will explain why I view the risk/reward ratio to be unfavorable in this price range too considering its valuation, profitability, and growth uncertainties.

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Source: DataRoma

Growth and Profitability Comparison

The next two charts put its growth and profitability in context by comparison against its close peers JPM and C.

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Source: Seeking Alpha

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Source: Seeking Alpha

Based on the data shown, we can see that BAC’s metrics are in general worse than JPM and the comparison with C is a bit mixed. For example, BAC has had lower revenue growth than JPM both in the past 3 years and 5 years. Looking ahead, its FWD growth estimate is also lower (3.99% vs. JPM’s 8.09%). In the meantime, note that BAC has also suffered a higher beta than JPM, indicating that it is more volatile and sensitive to market movements than its competitors. Its profitability metrics are also inferior to JPM across the board as seen in the second chart. Compared to C, the picture is a bit mixed. Its revenue growth has been better than C in the past 3 years and 5 years. But the FWD growth expectation is quite similar (3.99% vs. C’s 3.43%). It enjoys a better net margin and higher ROE than C. But the return on assets is similar (1.39% vs. C’s 1.3%).

Next, I will explain why I see a misalignment of the valuation metrics.

Valuation comparison

Despite the sizable gap between BAC’s growth and profitability metrics compared to JPM, BAC’s valuation metrics are comparable to JPM as shown below. its FY1 P/E ratio of 9.42x is only about 3% discounted from JPM’s 9.74x. If you recall from the chart shown above, the consensus estimate of BAC’s FWD revenue growth is only about ½ of JPM’s (3.99% vs. 8.09%). Thus, if based on the revenue growth rate, BAC’s PEG (P/E to growth rate ratio) would be almost 2x higher than JPM's. And further considering JPM’s far superior profitability, BAC’s PEG ratio when evaluated in earnings’ growth rate would be at an even higher premium compared to JPM. Compared to C, BAC’s valuation metrics are at such a large premium despite the mixed growth and profitability picture analyzed above. For example, its FY1 P/E ratio is about 17% higher than C, and its P/B ratio is more than 100% higher than C (1.0x vs. 0.48x).

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Source: Seeking Alpha

Other risks and final thoughts

Besides the performance and valuation issues, there are a few other risks worth mentioning. BAC is facing regulatory scrutiny over its overdraft fees and customer complaints. Both the Office of the Comptroller of the Currency (OCC) and the Consumer Financial Protection Bureau fined BAC for misconduct in these areas. In particular, the OCC ordered BAC to pay $250 million for charging customers excessive fees, opening unauthorized accounts, and withholding credit card rewards, among other things. Besides financial and legal ramifications, the developments could also raise concerns about BAC’s reputation and its future compliance costs. In terms of upward risks from the ER, BAC announced that its virtual financial assistant Erica surpassed 1.5 billion client interactions, totaling more than 10 million hours of conversations. BAC also said that Erica helped clients save more than $180 million in fees and interest in the first half of 2023. To me, this is a good sign of its progress toward digital transformation. It also declared preferred stock dividends and also an increase in its common dividends, showing both its financial strength and also its commitment to return capital to its shareholders.

All told, BAC current is a good stock for momentum trading in the near term. Its current conditions combined strong technical signs (price rallies on high volume) and a better-than-expected fundamental outlook. However, for long-term investors, I am concerned about the misalignment between its growth/profitability metrics and valuation metrics, especially compared to peers like C and JPM. I interpret the lack of insider buying (or the dominance of insider selling in the $30+ price range) in the past year as a symptom of such concern.

Source: seeking alpha