Bank of America (NYSE:BAC) reported second quarter earnings in mid-July that largely failed to impress. While the bank beat on the top and bottom lines, revenues fell 3% year-over-year, the efficiency ratio rose 3 points, pre-provision profits fell 9%, net interest income dropped 11% and net profits plunged more than 50% as the bank built its reserves in anticipation of economic volatility over the next few months.
BAC stock fell about 2% after the print.
Although Bank of America’s second quarter earnings were not good, Bank of America stock is a buy on this dip, mostly because when it comes to the big bank, the future is a lot brighter than the past.
Here’s a deeper look.
Weak Bank of America Earnings
Bank of America had a weak second quarter.
Sure, the bank beat Wall Street’s top and bottom line estimates. But those estimates were hugely depressed. Heading into the print, Q2 revenue estimates had dropped more than 5% since late February, while profit estimates had fallen by more than 50%.
In other words, given the context, a double beat quarter is nothing to celebrate.
The underlying trends were quite ugly. Revenues dropped 3%, paced by a plunge in consumer banking activity and sluggish wealth management activity, and offset somewhat by a surge in capital markets activity and investment banking. Expenses didn’t fall with revenues, so lost revenue scale drove operating margin compression and turned a 3% revenue decline into a 9% pre-tax, pre-provision profit decline. Making things worse was an 11% drop in net interest income on the back of a 57 basis point plunge in net interest yields.
Plus, Bank of America significantly built of up its reserves in the quarter, in order to protect itself against potential economic volatility over the next few months. Such reserve build killed profits. Year-over-year, profits dropped more than 50%.
Overall, it wasn’t a pretty quarter. It makes complete sense that Bank of America stock traded down after the print.
Better Times Ahead
Bank of America’s second quarter earnings report was a reflection of what has happened in the U.S. economy over the past three months, not what will happen over the next 6+ months.
If you do look forward, there’s reason to be optimistic on Bank Of America stock.
Yes, right now we are going in reverse in terms of the economic recovery. New York is essentially closing its borders. California, Texas, Florida and many other states are rolling back reopening measures.
Still, these business shutdowns and mobility restrictions are temporary. News on the vaccine front remains very promising. It increasingly appears that a vaccine is coming. Soon. When it does arrive, many of these restrictions will become a thing of the past.
Plus, America is only doing a better job at balancing virus mitigation efforts with attempts to maintain social and economic normalcy. For example, while California has shut down indoor restaurant operations, many cities in the state are now turning streets and parking lots into outdoor seating for restaurants. At the same time, retail shops, salons and fitness centers are increasingly moving their operations to parks and parking lots, too.
Mask wearing is also becoming more ubiquitous, and that should prove to be a leading indicator for decreasing Covid-19 spread and easing economic restrictions.
So throughout the back-half of 2020, I expect U.S. consumers, businesses and legislators alike to all get better at the Covid-19 balancing act. As they do, U.S. economic activity will perk up.
As U.S. economic activity perks up, Bank of America’s consumer banking and wealth management divisions will rebound strongly, while its capital markets division will sustain its current momentum.
All of that implies that BAC stock should rally over the next 6+ months.
Bank of America Stock to $30?
My numbers suggest that Bank of America stock will make a run towards $30 by the end of the year.
Bank of America netted almost $3 in earnings per share in 2019. Given macroeconomic weakness and huge reserve build, that earnings base will get wiped out in 2020.
But macroeconomic weakness will reverse course in 2021, and turn into macroeconomic strength as a vaccine eradicates Covid-19 fears and economic restrictions, and unleashes what is fairly robust pent-up consumer demand. Concurrently, Bank of America will significantly reduce its reserves in 2021 as the economy improves.
Thus, Bank of America’s profits should soar in 2021.
Will they soar all the way back to $3? Probably not. But my modeling suggests that $2.50 in 2021 earnings per share is quite likely.
Bank stocks normally trade at 12-times forward earnings. A 12-times forward multiple on $2.50 in 2021 earnings per share implies a 2020 price target for BAC stock of $30.
I think that’s where shares will trend over the next 3 to 6 months as the U.S. economic outlook improves.
Bottom Line on BAC Stock
Bank of America’s earnings report was ugly. But that’s a reflection of what has happened. You don’t buy and sell stocks because of what has happened. You buy and sell stocks because of what will happen.
For Bank of America, the future is brighter than the past. U.S. economic activity will improve over the next 6+ months. As it does, Bank of America’s fundamental growth trends will perk up.
So will BAC stock.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.