With a $364 billion market cap and an asset base (as of Sept. 30) that totals a gargantuan $3.3 trillion, Bank of America (BAC -0.47%) is a leader in the financial services industry. It has its hands in numerous areas, from consumer and commercial banking to capital markets and asset management.
Shares of this large financial stock have produced a fantastic 62% return just in the past 12 months. Does this strong momentum add fuel to the argument that Bank of America is a smart buy right now?
It's all about staying power
Warren Buffett-led Berkshire Hathaway owns just under 10% of Bank of America, which gives the average investor a vote of confidence that this is a worthy business to consider owning. The Oracle of Omaha looks for companies that have staying power, a description fitting for Bank of America.
The world will likely always need financial services providers that facilitate money movement between savers and borrowers and that conduct various capital market activities, among other things. I don't think that's a bold statement.
Bank of America has durable competitive advantages that support its industry position, both from existing rivals and newer entrants like fintech entities. The company's distribution capabilities, via a powerful digital presence and sprawling branch network, help it grow its low-cost deposit base and find new customers, creating revenue-generating opportunities.
And Bank of America's tremendous scale means that it can leverage its expense base to produce consistent profits. The brand's strength also resonates with current and future customers.
Bank of America, like its peers, isn't immune to the whims of the broader economic cycle. Recessionary times are inevitable. But the fact that they are unpredictable definitely adds risk and uncertainty to the equation. For what it's worth, Bank of America has historically been able to navigate whatever macro challenges have been thrown its way, which should give prospective investors confidence.
Practice patience
In the past year, Bank of America shares have crushed the S&P 500. Investors in the massive financial institution would've seen their capital almost double the return of the broader index in just 12 short months. It's hard to argue with this type of gain that can draw in investors who have been on the sidelines.
And with the prospects of lower interest rates and a regulatory-friendly administration entering the White House, you might think the good times will keep rolling. I, however, take a different view.
Smart investors will be critical of where a company's returns will come from. Since this is a very mature business, it's unlikely that there will be outsized growth. Indeed, diluted earnings per share rose at an annualized pace of 1.6% in the past five years. That isn't anything to get excited about.
Shareholders can bank on the 2.19% dividend yield, as well as the fact that the management team continues to shrink the outstanding share count. But these alone aren't enough to drive superior investment returns that outperform the broader market.
The final piece of the puzzle is the valuation. Note that in the past 12 months, Bank of America's price-to-earnings (P/E) ratio jumped 107%, from 8.3 to 17.3 today (as of Nov. 25). This more than offset falling earnings during the period.
It looks like the market's optimism toward Bank of America overshot to the upside, perhaps in anticipation of a lower-interest rate environment that could provide a favorable backdrop. As things stand right now, though, I think shares are richly valued. The current P/E multiple represents a 43% premium to the trailing-five-year average.
Bank of America is a dominant financial services enterprise with staying power. But I don't believe it's a smart buy. Investors should instead add the business to their watch lists and wait for a more attractive valuation.
