Here's a Major Benefit of Bank of America's Low Valuation

9/19/17

By John Maxfield, MotleyFool

One of the biggest advantages Bank of America (NYSE:BAC) has right now is that its stock trades for a low multiple to book value. It's one of only four banks on the KBW Bank Index that trades for a discount to book value per share, according to YCharts.com.

You may be wondering: That doesn't seem like an advantage. After all, isn't it better when a stock trades at a high valuation?

Yes, as a general rule it is.

But there's an exception to this rule for banks that buy back a lot of stock, as Bank of America does. In this case, a lower valuation makes buybacks a more potent way for a bank to create shareholder value by returning capital through share repurchases.

A bar chart showing Bank of America's quarterly buybacks dating back to the first quarter of 2016.

DATA SOURCE: BANK OF AMERICA. CHART BY AUTHOR.

This isn't rocket science. If a bank can repurchase, say, 10% more stock than another bank, but spend the same amount of money doing so, then all things being equal the first bank's shareholders will benefit more than the second's from the buybacks.

This advantage should prove to be especially beneficial over the next four quarters. That's because Bank of America recently announced that it had increased the amount of common stock it expects to repurchase between now and this time next year.

In the wake of the 2017 stress tests, the Charlotte, North Carolina-based bank disclosed that its board of directors has authorized the repurchase of $12.9 billion in common stock from the beginning of this past July through the end of next June. This includes approximately $900 million to offset stock issued as a part of compensation.

This is a lot of money. If you divide it by four, to reflect quarterly purchases, you get $3.2 billion. That's double to triple the amount that Bank of America spent on buybacks each quarter last year. In fact, only a little more than a dozen companies on the S&P 500 earn more than that in total net income each quarter.

Bank of America's chairman and CEO, Brian Moynihan, standing on the bank's trading floor in New York.

BANK OF AMERICA'S CHAIRMAN AND CEO, BRIAN MOYNIHAN. IMAGE SOURCE: BANK OF AMERICA.

As time goes on, moreover, Bank of America's shareholders can expect its pace of buybacks to accelerate. The bank's chairman and CEO Brian Moynihan has made it clear in the past that one of his main goals is to repurchase the billions of shares that the bank issued to raise capital during and after the financial crisis.

"We need to get back most of the shares we issued in the crisis, that caused all the dilution," Moynihan told Fortune's Shawn Tully six years ago.

And, to be clear, his mind hasn't changed. "We are working the share count down; at year end, we were at 11 billion shares," the 57-year-old banker wrote in his latest letter to shareholders.

In short, while short-term investors in the $2.3 trillion bank may wish that its valuation would shoot higher any day now, it's much better for long-term investors if the bank's shares continue trading at a low multiple to book value.

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