This Bank Stock Beat the S&P 500 in the First Half of 2024. Is It Still a Buy?
One of America's largest financial institutions is on a hot streak on Wall Street. Shares of Bank of America (NYSE: BAC) returned an impressive 18% between January and June, exceeding the S&P 500's 15% return.
The megabank is a household name and the second-largest holding in the portfolio of investing legend Warren Buffett. It shows that great stock ideas don't necessarily need to come out of nowhere.
But the timing of when you buy a stock can matter a lot, so it's fair to question whether Bank of America still has strong return potential over the latter half of 2024.
Management's vote of confidence
Bank of America is the country's second-largest bank, with more than $3.2 trillion in total assets. And given that it's a pillar of the U.S. financial system, it's important that it remain in tip-top financial shape. It recently passed its annual stress test, a mandatory annual evaluation established after the Great Recession to ensure that systemically important U.S. banks remain sufficiently capitalized to withstand a severe economic downturn.
Based on the test results, Bank of America's minimum Tier 1 Capital Ratio will be boosted from its current mandated 10% to 10.7% starting Oct. 1. Its ratio as of March 31 was 11.9% -- well in excess of both figures. In other words, Bank of America is doing more than the regulatory minimum to cushion itself from potential economic trouble.
In late June, management also announced plans for an 8% dividend hike that will take effect in Q3. While it won't deliver its Q2 earnings results until mid-July, such a solid hike announced in advance seems like a vote of confidence from management that things are going well.
Interest rate cuts could benefit Bank of America
In 2022, the Federal Open Market Committee began aggressively raising the federal funds rate -- the interest rate banks charge each other for overnight loans -- to cool surging inflation. High inflation is like the grease fire in your grill on July Fourth. Left unchecked, rampant inflation hurts consumers. Rate hikes are the metaphorical fire extinguisher; ideally, they slow the economy enough that inflation decreases to a healthy low-single-digit percentage rate.
It has been almost a year since the last of the Fed's rate hikes, and the economic data are showing their impact. Unemployment is creeping higher, the housing market has slowed, and inflation has dropped dramatically.
US Existing Home Sales data by YCharts.
These trends have fueled speculation that the Fed will begin cutting rates in the fall. Why cut rates? The central bank's goal is to tame the fire, not put it out. Keeping rates high for too long risks dragging the economy into recession. All banks are exposed to broad economic conditions -- recessions take a toll on their businesses and their stock prices.
Rate cuts could reduce Bank of America's net interest income (the loan interest it receives minus the interest it pays on deposits). However, lower rates could boost economic activity enough to offset those lost profits -- for example, by loosening up the housing market and boosting mortgage volumes.
Additionally, the Fed's rate hikes pushed the value of bonds lower. As a result, Bank of America is now sitting on unrealized losses of more than $100 billion in its bond portfolio. Although it can avoid taking those losses simply by holding all those bonds to maturity -- and it plans to -- it would be less painful if they regained some of their value due to rate cuts. So overall, rate cuts could prove a net positive for Bank of America.
Is the stock a buy today?
Nobody can know for sure if or when a recession might occur, nor can anyone reliably predict such an event's severity. That's why investors shouldn't buy or sell Bank of America stock based on speculation. Instead, they should pay attention to management's commentary during earnings and look for signs of confidence, such as when a company announces a dividend hike ahead of its usual schedule.
Assuming the U.S. economy remains stable, is Bank of America a buy today?
Investors can value the company based on its earnings and tangible book value. During the past decade, shares have averaged a price-to-earnings ratio of about 15 and a price-to-tangible-book-value ratio of 1.4, and their valuations are on par with those averages today. Additionally, analysts believe Bank of America's earnings will grow by more than 8% annually for the next three to five years.
BAC PE Ratio data by YCharts.
Based on management's confident dividend raise, a fairly valued stock, healthy earnings estimates, and the potential for rate cuts in the second half of the year, shares still look like a buy.
If the stock sticks near its long-term valuation averages, investors could see total annual returns of 10% to 11% from earnings growth and dividend yield. That wouldn't be as impressive as the shares' performance during the past six months, but the stock could still be a strong contributor to your portfolio.
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Bank of America is an advertising partner of The Ascent, a Motley Fool company. Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bank of America. The Motley Fool has a disclosure policy.