Is Bank of America (BAC) A Buy? || Warren Buffett's Favorite Bank Stock Analysis & Intrinsic Value

i actually said specifically today that a long long time before we saw the sheriff bank of america uh we're very happy we got 700 million shares and and you know i i i like the business i like the valuation and that i like the management very much so that i think you'll see that for a long time in our holdings buffett has sold off most of berkshire's other bank stocks but for some reason he's not only kept his existing shares in bank of america but he's also bought nearly 100 million shares in the past year berkshire hathaway owns over 12 percent of bank of america's shares outstanding so let's explore bank of america and see why this bank is worthy of being warren buffett's second largest holding banks make money in a ton of different ways but the main way is by making loans and other investments with money that customers deposit bank of america also makes money through fees charged to customers and investment banking activities like securities trading and underwriting for companies going public banks in the u.s are in one of the most heavily regulated industries and are under the control of the federal reserve see banks can't just go out and loan all of the money a customer deposits instead the fed sets reserve requirements that determine how much the bank can actually loan for instance bank of america's reserve requirement is about 10 so they can loan up to 90 of the money from customer deposits the federal reserve changes this requirement based on how the overall economy is doing and will make the reserve requirements higher when too much money is being loaned and lower requirements after an economic downturn to encourage lending as you can see banks are the definition of a cyclical industry since they directly cause the economy's cyclicality bank of america's main business segments are consumer banking global wealth and investment management global banking in global markets and the bank also has a miscellaneous segment called all other consumer banking deals with mortgages credit personal auto and small business loans and products guim deals with wealth management for high net worth individuals and retirement accounts global banking includes loans and advisory services for commercial industries and investments for customer deposits with the federal reserve and other low-risk comparable investments the global markets segment is basically the investment banking part of bank of america where all the trading and securities market making takes place the bank trades on behalf of clients and uses some of the bank's own deposit money to trade securities like public equities and fixed income they also trade over-the-counter derivatives like swaps and forward contracts to increase profits and hedge their exposure to loans and investments they already have in case you were wondering yeah these are the same ones that michael bury used to short the financial crisis in 2008 though don't worry too much about another financial meltdown like 2008 since then banks have been subject to extremely strict regulation by the federal reserve and cannot use much of their own money to bet on risky trades like before the financial crisis you can rest assured knowing the federal reserve and the u.s government are literally breathing down bank of america's neck with absolutely everything they do the all other section includes investments to hedge risks adjustments for when investments lose value expenses for litigations and investments in environmental social and governance policies bank of america's financial numbers were unsurprisingly down last year due to the effects of the pandemic overall net revenues decreased slightly to about 85 billion dollars in 2020 down from 91 billion in 2019 banks across the globe decreased the number of loans being originated and bank of america more than doubled the cash on hand to prepare for trouble so lower consumer spending combined with low interest rates cause revenues and profits to decrease take a look at part of the bank's balance sheet notice how the cash increased loans decreased and total deposits skyrocketed to almost 1.8 trillion dollars that's trillion with a t overall total liabilities total just over 2.5 trillion dollars no it's okay i know it sounds like a lot but considering the deposits are over 70 of that it's not that bad runs on the bank are highly unlikely so people won't be demanding all of their money at one time bank of america actually has less leverage than most other banks and they're pretty conservative with reserves and risk exposure that's probably one reason why buffett likes the stock so much due to decreasing interest rates bank of america's net interest yield decreased to about 1.9 percent in 2020 and could stay lower in the future due to low interest rate targets from the federal reserve apart from the numbers buffett heavily considers an investment's economic moat and management team bank of america is the eighth largest bank in the entire world and therefore operates an efficient scale mode bank of america is given ample investment opportunities that smaller banks just don't have they can keep costs low compared to their total assets since they deal with so much money another thing is that bank of america is so large and so heavily involved with consumer banking that it is virtually too big to fail in the extremely remote event of another financial crisis in our lifetimes bank of america will certainly receive a taxpayer bailout regardless of whether you agree with it or not additionally since berkshire hathaway is such a large shareholder in hard times the bank can sell berkshire convertible debt as they did in 2011 and buffett will buy everything he can get his hands on another moat bank of america has is its branding mode the bank of america brand has been around since 1998 and has more customer accounts than any other us bank customers rarely take out all of their money and leave the bank in fact they usually just use the bank they're at for their personal finances like mortgages auto loans and credit cards therefore the large customer base is one way bank of america fends off competition from other new entrants to the financial sector now i'm not saying brick and mortar banks are the future in fact i'd bet that fintech companies will take over most of the banking sector eventually but for at least the next decade bank of america has a group of loyal legacy customers that will almost certainly not leave the bank bank of america's ceo and chairman of the board is brian moynihan moynihan joined bank of america in 2004 after an acquisition and became ceo in 2010 the ceo before him made some of the worst acquisitions in the history of finance and moynihan stepped in to mend the bank back together with the extensive help of the federal government he has proved that he can build back a struggling company buffett sees him as a trustworthy individual i don't know him so i can't comment but his statements and discussions with analysts seem to prove that he is transparent the executive team is heavily compensated in long-term stock awards with the ceo making a 1.5 million dollar base salary and over 23 million dollars in stock options other executives are also compensated in stock awards but close to half of their compensation is from yearly bonuses it's no secret that bank of america's employees and other finance employees are heavily compensated especially in stock awards but i wouldn't say that makes them prone to make decisions for the long-term goals of the company as the economy rebounds from some of the effects of the pandemic it's reasonable to assume that bank of america's revenues will increase in the next five years and it's highly likely that they will at least remain constant or slightly increase for the rest of the decade even though we just don't know how long interest rates will stay this low bank of america's customer deposits have significantly increased due to stimulus payments this will probably cover any decreases in revenue from lower interest yields as there will be a higher volume of loans i think it's unlikely that bank of america will grow customer accounts much more than they already have since they've already dominated the american market and will probably not expand into any more global markets therefore i have projected a revenue growth rate of 3.5 percent for the next three years which is what the bank has also projected 1.5 percent for the three years after that and one percent for the last four years in this decade those rates are slightly lower than the expected u.s gdp growth i've made it slightly lower since i really don't know what the federal reserve is going to do and deposits could remain constant or decrease over the years as consumers move to more low-cost fintech banks alright so after all that let's figure out the bank's intrinsic value so 90 percent of bank of america's revenues are from the u.s and the rest are from mainly western europe and asia i've weighted the equity risk premiums for these regions considered that the bank has a high credit rating used 1.6 percent as the 10-year risk-free rate and have come up with a discount rate of about 6 percent i've used the financial statements over the years and created an adjusted operating margin average of about 30 percent of revenues i expect that it will remain at this amount indefinitely i've also used a reinvestment rate of 4.5 percent of revenues per year to cover property equipment and infrastructure costs the tax rates are expected to be about 14 percent due to tax credits from the bank's significant investments in environmental projects all things considered we get an intrinsic value of about 58 dollars per share which is higher than the current stock price of 39 at current prices i'd say the market is pricing in about a 9 return over the long term from stock buybacks and dividend payments from expected free cash flows nine percent is alright i guess but for my estimates it's no wonder why buffett was buying all the stock he could when it was at about 24 dollars per share at this price the stock was expected to yield about 13 which is extremely hard to achieve for a company like berkshire hathaway and as above buffett's 10 investment return target but for retail investors like us we have to consider that there are over a thousand different ways the bank could over perform or underperform this model the bank's success really comes down to the macro economy as a whole which has a ton of moving parts so don't take those risks lightly but if you do want to invest in bank of america it definitely doesn't hurt to have buffett on the same side of the table i hope this helps please leave a like and subscribe if you enjoyed what do you think about buffett's second largest investment let me know in the comments and i'll see you again next time you

Channel: Bull Investor

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Keywords: stock market investing, value investing stocks, intrinsic value, how to analyze stocks, warren buffett stocks, value investing, growth stock investing, intrinsic value of a stock, bac stock, bank of america stock, bank of america stock analysis, bac stock analysis, bac stock investing, warren buffett banks, bac buy, bac, bank of america, bank of america growth, bank of america stock buy, bac stock buy, warren buffett investing, bank stocks, bank of america intrinsic value

Id: xl542qL3EEc

Length: 14min 58sec (898 seconds)

Published: Sat Mar 20 2021