TipRanks Smart Dividend Newsletter – Edition #32
Hello and welcome to the 32nd edition of TipRanks’ Smart Dividend – a weekly Newsletter providing you with investment ideas for safe-bet quality stocks that are outstanding dividend payers, compared to their peers.
Today’s dividend stock recommendation is the world’s second-largest bank. But first, let us present a brief investment thesis, supporting our recommendation.
Investment Thesis: Banking on Resilience
The last two years have been challenging for American banks. Part of the struggle was due to the Federal Reserve’s stringent monetary policies, which dampened the economic forecast and affected investor enthusiasm, especially in sectors beyond technology. While higher interest rates can increase banks’ margins, they also tend to reduce loan demand, and a slowdown in business activity impacts both the demand for and the supply of loans. Furthermore, the financial sector was hit hard by the regional banking crisis in March 2023, severely damaging what little was left of investor confidence in banks.
However, as Warren Buffett once observed, “It’s only when the tide goes out that you learn who has been swimming naked.” This saying also implies that when the tide recedes, it’s clear who was well-prepared with full diving gear. Presently, as the fear of imminent economic disaster has almost vanished and the gravest anticipated outcome is a “soft landing,” large, solid, and profitable financial institutions are regaining their allure for investors. Their recent earnings reports have indicated that the concerns regarding the U.S. financial system’s stability were significantly overstated.
The inflation has also significantly declined, allowing the Federal Reserve to begin monetary easing in the first half of this year. While there could be some negative surprises stemming from macro developments, political instability, or geopolitical events that might affect investor flows, the largest U.S. banks remain a beacon of stability, especially in the sense of their shareholder compensation.
Their shares have not yet fully recovered from 2023’s losses, which means that their valuations remain modest; this may not be the case in a few months from now as improving short-term outlook is expected to continue supporting share prices and propping up the price multiples. Meanwhile, their sustained long-term potential and generous dividends and buybacks make them an attractive choice for those seeking steady income.
Quality Dividend Stock: This Week’s Top Pick
Bank of America (BAC) is an American multinational investment bank and financial services provider. BAC is the second-largest bank in the U.S. and in the world by market capitalization after JPMorgan Chase (JPM). It is the world’s third largest investment bank by revenue, after JPM and Goldman Sachs (GS).
Bank of America is a global, systemically important bank, serving over 69 million consumer and small business clients in the U.S. and small and medium (SME) companies, large corporations, and governments globally. BAC’s operations are primarily focused in the U.S., where it gets the vast majority of its revenue, but it is also present in numerous countries around the world.
Bank of America offers a full range of banking, investment management, wealth management, investment banking, and other financial and risk management products and services. The bank is organized into four major divisions: Consumer Banking, Global Wealth and Investment Management (GWIM), Global Banking, and Global Markets.
The Consumer Banking division, the largest division in the company responsible for 42% of the total revenue, works through the Retail and Preferred & Small Business segments. The Retail segment provides U.S. consumers with a full range of financial products and services and also offers private clients access to digital banking and a retail banking network. BAC has one of the largest coverages in consumer financial services in the country. The Preferred and Small Business segment offers U.S. banking and investment clients access to Bank of America banking and Merrill investment solutions. It also serves entrepreneurs and SMEs by providing them with cash management, lending, and investment solutions.
The GWIM division works through Merrill Wealth Management and Bank of America Private Bank segments. Merrill offers clients investment advice and financial guidance to help them create personalized strategies to realize their goals. Bank of America Private Bank segment provides planning and financial solutions to help families who are managing substantial wealth.
The Global Banking division works through three segments: Business Banking, Global Commercial Banking, and Global Corporate & Investment Banking. The Business Banking segment delivers integrated financial guidance and solutions to U.S. SMEs. These offerings include credit, treasury, trade, foreign exchange, equipment finance, and merchant services. The Global Commercial Banking segment offers a full suite of financial services to business clients around the world, including treasury, lending, leasing, financial guidance, and debt and equity underwriting services. The Global Corporate & Investment Banking segment provides municipalities, government agencies, and large corporate clients with access to a full suite of treasury, lending, leasing, advisory, and debt and equity underwriting services.
The Global Markets division offers a variety of services across international debt, equity, commodity, and foreign exchange markets. It serves numerous institutional investor clients, including hedge funds, asset managers, pension funds, and others. These services include liquidity and hedging strategies, investment insights, and many more.
Bank of America traces a large part of its roots to the U.S.-based Bank of Italy, founded in 1904 in San Francisco, California, to provide various banking options to Italian immigrants in the country. In 1928, the Bank of Italy acquired Bank of America, Los Angeles, which itself emerged from a series of mergers between Los Angeles-based banks between 1909 and 1923. The newly merged entity took on the name “Bank of America National Trust and Savings Association” in 1930.
Following the passage of the Bank Holding Company Act by the U.S. Congress, “BankAmerica Corporation” was established in 1968 to own and operate Bank of America and its subsidiaries. This action facilitated the rapid growth and expansion of the company, which quickly established a prominent market share.
In 1998, when BankAmerica was already a large and prominent U.S. banking institution, it suffered outsized losses stemming from Russia’s bond default. As a result of its failed investments and subsequent losses, it was acquired by NationsBank of Charlotte, a very large bank founded in 1874, in what at the time was the largest bank acquisition in history. While NationsBank was the acquirer, the merged bank took the better-known name of Bank of America, which resulted in the forming of the “Bank of America Corporation”. However, the merged company was and still is headquartered in Charlotte and retains NationsBank’s pre-1998 stock price history.
Throughout its history, Bank of America grew and expanded at a fast clip, helped by numerous acquisitions. One of BAC’s most significant acquisitions was the 1983 purchase of Washington State Bank Seafirst Corporation, which was the biggest U.S. interstate bank merger of all time. After purchasing Security Pacific Corporation of California in 1991, Bank of America became the first bank to offer coast-to-coast operations in the country. BAC expanded further in its presence and total assets when it acquired the seventh largest bank in the United States, FleetBoston Financial, in 2004, and LaSalle Bank Corporation in 2007.
The buyout of a transaction-processing firm National Processing in 2004, and a merger with MBNA Corporation in 2006, helped enlarge BAC’s credit card business, turning the company into the leading issuer of credit cards in the nation. The 2007 acquisition of U.S. Trust Corporation, an investment firm that manages investments for high-net-worth individuals, allowed BAC to gain a strong position in the wealth-management business. The buyout of Countrywide Financial in 2008 made Bank of America the leading mortgage originator and servicer in the U.S.
One of the most important BAC acquisitions was the purchase of Merrill Lynch for $50 billion in 2008 when ML was within days of collapse due to the massive trading losses connected to the mortgage crisis, which developed into the Global Financial Crisis (GFC). The bank was compelled to pursue the acquisition by the U.S. government, which injected a significant amount of money into BAC to help it deal with the capital shortfall at ML. The federal aid was repaid in full by December 2009.
The acquisition of Merrill made Bank of America the largest financial services company in the world at the time, as well as the number one underwriter of global high-yield debt, the third largest underwriter of global equity, and the ninth largest adviser on global mergers and acquisitions.
However, in 2011-2014 the bank underwent downsizing, streamlining its businesses and cutting expenditures as revenues continued to decline because of the post-GFC regulations and a slow economy. Bank of America focused on growing its online and mobile banking platforms as part of its new strategy. In 2015, Bank of America began expanding again, this time organically, opening multiple new retail branches, which led to a sharp growth in consumer deposits.
Today, BAC has $3.2 trillion in consolidated assets and holds $1.9 trillion in consumer and GWIM business deposits. It is the largest U.S. provider of online and mobile banking functionality, serving over 57 million users. In addition, the company has nearly 4,000 branches and more than 16,000 ATMs. BAC commands the second-largest share of domestic deposits after JPM. BAC is also the leading global bank for financing; it holds a global portfolio of $0.6 trillion in commercial loans. Its Global Banking segment serves 95% of the U.S. Fortune 1,000 and 75% of the Global Fortune 500 companies.
On October 17, Bank of America reported its Q3 2023 financial results. Revenue and EPS exceeded analysts’ expectations, as was the case in most quarters for which these estimates were available. Particularly impressive was the fact that in this difficult macroeconomic environment, the bank managed to increase both its loans and leases outstanding, as well as its credit/debit card spending, leading to a revenue increase from the previous year. That increase, combined with greater efficiency due to its highly effective management, led to a solid 10% year-on-year growth in net income. Adjusted EPS rose by 11% year-over-year, a third consecutive quarter of double-digit growth. In the past three years, BAC’s revenues rose at a CAGR of 8.6%, and EPS grew at a CAGR of 20.7% – very impressive for one of the most regulated institutions on the globe.
As for BAC’s financial health, all of the metrics relevant to the financial institutions flash bright green. It has a stellar balance sheet with a moderate Assets-to-Equity ratio of 11x; almost 70% of the bank’s liabilities are low-risk sources of funding (primarily consumer deposits). BAC has a low Loans-to-Assets ratio of 33%, as well as a moderate Loans-to-Deposits ratio of 55%. The bank has a very low level of bad loans (0.5%), while its bad loan allowance is 265% (versus the 100% minimum sufficiency level for systemically important banks).
Bank of America’s debt is very highly rated, standing among the highest-rated banks in the world: “A-” at Standard & Poor’s, “Aa1” at Moody’s, and “AA-” at Fitch.
Particularly, Fitch said that the high credit rating reflects BAC’s “robust retail and commercial franchises, and Fitch’s view that BAC’s consistent strategy of responsibly growing the franchise over the last number of years will result in relatively lower credit costs and strong, consistent earnings performance over the long term.” Fitch applauded the bank’s “leading franchise across many of its core businesses, diversified business mix and steady strategy that Fitch expects will result in more stable through-the-cycle financial performance relative to peers.” The rating agency added that “BAC continues to hold leading or near-leading market shares in many categories across its segments, including a leading market share in retail deposits and small business lending in the U.S.”
Moreover, Fitch believes that “BAC is very well-positioned for the ongoing advancement of digitization within the financial services industry.” BAC has been an innovator throughout its history; for example, it introduced the first-ever bank credit card in the 1950s. Its heavy investment in innovation continues to bear fruit, helping it to remain a global financial leader in the age of digitization.
These and other strengths combine to support Bank of America’s capital allocation strategy, which strongly aligns with shareholder interests. Bank of America is not just a dividend-paying company, it has a long dividend track record dating back to 1986. While the GFC forced BAC, like almost all banks and many companies from other industries, to substantially cut its dividend, the company returned to payout increases the moment the danger passed. It has demonstrated a commitment to increasing dividends annually since 2009. In the past three years, BAC’s dividend-per-share growth was 7.7% p.a., on average, which is higher than most of its peers. The latest such increase was in August 2023, with the payout rising by 9%.
Bank of America’s current dividend yield is 2.71%, higher than the Financial sector’s average of 2.11%. Given the company’s profitability, cash flow, and financial stability, as well as its low payout ratio of 26%, shareholders can expect the payouts to grow for years to come.
In addition to dividends, BAC compensates its shareholders through buybacks on an opportunistic basis. The bank has retired almost 20% of its stock in the past five years. In the calendar year 2022, BAC bought over $5 billion of its shares; this year, the repurchases have slowed substantially on the back of the economic uncertainty, but they are expected to pick up in 2024.
Bank of America’s stock is one of the favorite investments of Warren Buffett. His company, Berkshire Hathaway (BRK.B), owns more than 1 million BAC shares, or about 13% of the bank’s total stock. Bank of America is the second-largest holding in Berkshire’s portfolio, representing 9.5% of the company’s holdings. Berkshire has increased its BAC holdings during 2023. Buffett’s sizable holdings of BAC’s shares can be viewed as a seal of approval, as the Oracle of Omaha is known for his choice of stocks of quality companies.
BAC’s shares reached their post-GFC high in January 2022, but since then lost about 31%, even after accounting for their recent rally. This isn’t unique to Bank of America, as all banking stocks have been under pressure from the economic uncertainty and rising interest rates, as well as from investor worries about long-duration assets on the banks’ books in a rising-rates environment. Besides, in March this year, the collapse of three mid-sized lenders had investors in jitters, despite the fact that “The Big Four”, including BAC, were in no danger, as the Fed’s Stress Tests later confirmed.
Since then, market sentiment significantly improved, as the economy remained resilient and inflation rates fell, allowing policymakers to signal monetary easing in 2024. A decline in interest rates would increase banks’ asset values and real equity, while the strengthening economy and lower borrowing costs would increase demand for loans. For this reason, analysts have been upgrading their outlook on large banks’ stocks, including BAC, in recent months.
Bank of America’s stock has ended 2023 almost unchanged, after dropping in the wake of the regional bank crisis in March, trading sideways for several months, and eventually surging by 34% from the year’s low at the end of October following improved outlook and sentiment, as well as BAC’s stellar financial results.
As a result of its earlier declines, BAC’s stock is trading at modest valuations, with its TTM P/E of 9.4 and a Forward P/E of 10.1 representing 14% and 10% discounts, respectively, to the Financial sector’s averages. When compared to its peers in the industry, BAC comes closer to the lower end of the price range. Besides, the bank trades at a ~30% discount to its fair value.
TipRanks-scored top Wall Street analysts see an average upside of 4% for the stock in the next 12 months; given the company’s ability to produce outsized profits even during times of economic hardship, it may well surprise on the upside. Hedge funds and individual investors clearly believe that this will be the case, as both these groups have upped their BAC holdings in recent months. BAC carries a TipRanks Smart Score rating of “Perfect 10” with a “Moderate Buy” recommendation:
To conclude, we believe that Bank of America’s prudent management and vast financial strength will allow it to adapt to the evolving financial landscape, with its strategic initiatives aligning with the dynamic market demands. BAC’s solid profitability and promising growth metrics underpin its dividend sustainability, as well as consistent payout growth going forward, while its modest valuation presents a significant value opportunity. Thus, we view Bank of America as a compelling proposition for investors seeking steady income and long-term value.
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