Sunday, June 23, 2024

Bank of America (BAC) Payout Potential for Income Investors

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Headquartered in Charlotte, North Carolina, Bank of America Corporation (BAC), the financial juggernaut boasting $3.20 trillion in assets, has been a boon for investors lately. Over the past six months, shares of the mega-bank have delivered returns of 50.2%. Impressive, isn’t it?

Moreover, BAC now ranks as the second-largest holding in Berkshire Hathaway’s (BRK.A) (BRK.B) portfolio, with well-known investor CEO Warren Buffett showing confidence in the bank’s long-term success. Berkshire owns around 1.03 billion shares in Bank of America, representing a 13.1% stake as of December 31, 2023.

Warren Buffett’s knack for investing in profitable ventures has made Berkshire a top conglomerate. Berkshire’s investment in BAC is driven by factors including the bank’s robust financial position, diversification of financial services, and growth potential. Buffett, known for seeking companies with solid fundamentals and competitive advantages, sees Bank of America meeting his standards. So, does this signal a bullish outlook on the bank’s prospects?

Here’s a closer look at whether BAC holds promise for investors seeking to emulate Buffett’s investment philosophy.

How Did the Bank Perform in Q1?

Bank of America’s top line in the fiscal 2024 first-quarter results revealed a marginal year-over-year decline, reaching $25.82 billion due to the lower net interest income (NII) generated across its business segments. NII decreased by 3% year-over-year to $14.03 billion, with higher deposit costs outweighing increased asset yields and modest loan growth.

Despite the drop, the company delivered better-than-expected NII performance, which is $100 million higher than the last quarter. BofA had predicted a decrease of $100 million to $200 million from the fourth quarter of 2023 to the first quarter of 2024. Moreover, BAC’s Global Wealth and Investment Management segment reported a record revenue of $5.60 billion, up 5% year-over-year.

In addition, BAC’s net income applicable to common shareholders fell by 19.8% from the prior year’s quarter to $6.14 billion. Its EPS came in at $0.76, representing a decline of 19.2% year-over-year.

Compared to the previous year’s period, the company’s provision for credit losses rose by 41.7% to $1.32 billion. Also, its total net charge-offs increased 85.6% year-over-year. The net charge-offs as a percentage of average loans and leases outstanding stood at 0.58%, compared to 0.32% in the prior-year quarter.

On the other hand, the company’s CET1 ratio came in at 11.8%, compared to 11.4% in the prior-year quarter. Also, its total loans and leases rose 0.2% year-over-year to $1.05 trillion. As of March 31, 2024, Bank of America’s liquidity remained strong, with cash and cash equivalents at $313.40 million, albeit a decline of 5.9% from $333.07 billion as of December 31, 2023.

Brian Moynihan, BAC’s Chair and CEO, said, “We reported a strong quarter as our businesses performed well, adding clients and deepening relationships. We reached 36.9 million consumer checking accounts, with 21 consecutive quarters of net checking account growth. Our Wealth Management team generated record revenue, with record client balances, and investment banking rebounded.”

“Continued strong earnings and strong expense management both position our company to continue to drive our market leading positions across our businesses,” Moynihan added.

What’s Ahead?

Street expects BAC to generate a revenue of $25.31 billion for the second quarter (ending June 2024), indicating a slight increase compared to the same period last year. The company’s earnings per share is expected to stand at $0.81 for the ongoing quarter.

For the fiscal year ending December 2024, analysts anticipate a revenue surge of 3.4% year-over-year, reaching $101.91 billion. They forecast that earnings per share will reach $3.23, up 4.7% year-over-year. Further, the company’s revenue and EPS for the fiscal year 2025 are expected to grow 2.5% and 8.7% year-over-year to $104.49 billion and $3.51, respectively.

Additionally, the company has comfortably surpassed consensus revenue estimates in three of the trailing four quarters, so there is a low likelihood of another miss in the upcoming period.

Dividend Sustainability Makes It Attractive for Income Investors

Thanks to its robust capital strength, with a common equity Tier 1 capital of $197 billion (exceeding regulatory requirements by $31 billion), the bank was able to support clients and return $4.4 billion to shareholders in the first quarter through dividends and share repurchases.

BAC rewards shareholders a dividend of 2.5% (or $0.96 annually), significantly higher than the S&P 500’s average of 1.4%. That means BAC shareholders get over 78% of the income generated by America’s leading stock index.

Moreover, BofA has a commendable track record of dividend increases, with compound annualized growth rates (CAGRs) of 9.3% over the past three years and 10.5% over the past five years. With a record of 10 years of consecutive dividend growth, the bank has shown a steady and reliable history of doing so.

The company has a payout ratio of 32.5%, demonstrating a prudent balance between rewarding shareholders and retaining earnings for future growth. While past performance does not indicate future results, the company’s steadfast commitment to dividend growth suggests that the management is unlikely to break its streak in the near term.

Bottom Line

Despite the mixed financials, BAC’s recent first-quarter report showcased the strength of its diversified business model. Notably, the bank saw a significant 35% increase in investment banking fee revenue, driven by a timely rebound in deal activity. Also, its sales and trading revenue experienced a notable resurgence, marking its most robust first-quarter performance in over a decade.

Moreover, the company’s dividend sustainability and growth prospects highlight its attractiveness for income-focused investors seeking reliable cash flow and capital appreciation.

According to Statista, the U.S. wealth management market is expected to expand at a CAGR of 7.9%, resulting in a market volume of $87.35 trillion by 2028. Meanwhile, the U.S. retail banking market is projected to hit $91.47 billion, growing at a CAGR of 4.3% during the forecast period (2024-2028).

Given the inflationary pressures, the Federal Reserve is unlikely to cut rates in June, meaning interest rates will remain higher for longer. While this may enable banks to charge higher loan rates, they may face increased deposit costs, potentially impacting their margins. Bolstered by an adjusted ROTCE of 13.88% and a CET1 ratio of 11.8%, we believe the company is well-equipped to thrive in a higher interest rate environment.

Looking at valuation, BAC’s forward non-GAAP P/E of 11.89x is 14.1% higher than the industry average of 10.42x. Likewise, in terms of forward Price/Sales, the stock is trading at 2.96x, 18.4% higher than the industry average of 2.50x.

So, while existing shareholders have reason to cheer, potential investors might wait for a better entry point in this stock.

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