The ‘Buy the Dip’ case for Bank of America Stock is not that simple

<p>It’s relatively easy to make a bull case for Bank of America (NYSE: BAC) right now. The BAC share has fallen by an outstanding 26% in just eleven trading sessions. And at these lowest prices, the stock looks cheap – too cheap.

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Above all, the BAC share is now traded below book value. When we go back to 2017, it is only dipped under a single book on a few occasions. Each of these cases was short and represented a short-term buying opportunity.

The result also makes the share look attractive. Shares are now trading at less than 10x earnings per share in 2019. The multiple to the 2020 consensus EPS estimate – currently $ 2.97 – is below 9x.

These multiples are the direct result of a sale that seems to be driven by the fear of the rapidly spreading coronavirus. And while a significant economic impact in the short term seems increasingly likely, the long-term fall for BAC shares is unlikely to be broken. To put it simply, it looks like an unmotivated sale and a buying opportunity.

I’m sympathetic to that case. I have previously recommended BAC shares, especially during the market’s latest correction at the end of 2018. But this time I am not at all as bullish. There are reasons why this decline makes sense, and reasons why investors who want to buy greater market weakness should focus their attention elsewhere.

We’ve been here before

In terms of earnings and book value, the BAC share is undoubtedly cheap. But it has been somewhat cheap for most of the last decade.

In fact, the share was traded below book value for several years after the financial crisis. It did not clear 1x book until 2017, after a horrific demonstration after the US presidential election in November 2016.

A multiple of price income below 10x is admittedly out-of-line in relation to the latest trade, but not without equal. In relation to subsequent 12-month figures, the BAC share received a single-digit PE multiple both at the beginning of 2016 and on several occasions last year.

It is worth pointing out that the shares rose sharply on both occasions, and history therefore suggests that a PE multiple below 10x is really too cheap. Still, the stock has been quite cheap for over a decade now. And there is reason to believe that the stock right now should be cheaper than it has been for several years.

Not just a short-term problem

There is more going on here than just the fear of coronavirus. In response to this fear, the Federal Reserve lowered its reference rate by 50 basis points last week. It follows only three cuts in 2019 only.

All other things being equal, these cuts will put pressure on BofA’s results. They reduce the net interest margin, the difference between what the bank generates from loans and what it pays to depositors.

In fact, we’ve already seen it play out. During the fourth quarter, Bank of America’s net income attributable to ordinary shareholders decreased by more than 4% compared to the same period last year. A decline of 3% in what the bank calls net interest income was an important driving force.

This month’s interest rate cut will increase press results in 2020. Last year’s move was already expected to have a negative impact during the first half of the year. Meanwhile, traders are now pricing another 75 basis points this month, and a return to zero interest rates would not be a surprise.

As a result, it seems increasingly likely that BofA’s earnings will decrease throughout the year. It does not even include potential effects from credit losses, weaker credit card results and other macro-driven effects. Both speed and macro weakness may well remain in 2021 and beyond. In that context, BAC stocks should probably be cheap.

Better alternative than BAC stock

Again, I am sympathetic to the case that BAC shares may be too cheap from a long-term point of view. This is still one of the best banks out there: I have long argued that Bank of America and JPMorgan Chase (NYSE: JPM) are the two most attractive major bank stocks on the market.

But an investor buying Bank of America shares here must have some faith that the US economy will recover quickly, if it weakens at all. And if it turns out to be, there is no shortage of stocks that have fallen sharply.

In fact, other finances have struggled almost as badly. Over the past month, the BAC share has fallen further than other major finances – but not by much. It is down 25%. JPM shares have fallen by 21%. Wells Fargo (NYSE: WFC) and Citigroup (NYSE: C) are both away with 22%.

Airlines and other travel-related stocks have been routed but should recover if Coronavirus fears are exaggerated. Many dealers have crashed. Casino stocks look exciting, with Wynn Resorts (NASDAQ: WYNN) threatening a three-year low and US games such as Penn National Gaming (NASDAQ: PENN) and Eldorado Resorts (NASDAQ: ERI) collapsing.

If the US economy performs better than feared, BAC shares will no doubt flow. Other names are rising further – and do not face long-term challenges from a Fed fund rate that could return to or near zero in the coming years. But if the fear is justified, it is likely that BAC shares will not end up before the market does.

In other words, this sale is more logical than it may seem – and does not yet seem to be a convincing opportunity.

Vince Martin has been covering the financial industry for nearly a decade for InvestorPlace.com and other stores. He has no positions in any of the mentioned securities.