Bank of America (BAC) is a multinational financial services company. The firm offers a range of banking and financial products through its subsidiaries. I am neutral on the stock.
Much has been made of the historical correlation between banking stocks and higher implied interest rates. Although I do agree that certain banking stocks will do well, I need to disagree with the rhetoric that they will rise risk-free.
Bank of America is a stock that I think may flatline moving forward, and here’s why.
Income Statement Concerns
Bank of America is carrying with it extremely high wages. The company’s payroll to revenue ratio of 0.4x suggests that it’s facing diminishing profitability due to workers’ wage demands. The issue with wage growth is that it’s not as elastic as other input costs, as salary negotiations aren’t a simple function of supply versus demand.
Daunting Stress Test
The banking giant passed its stress test with flying colors in 2021 with a CET 1 ratio of 11.8%, comfortably exceeding the required benchmark of 9.5%.
Stress tests may be a tad lackluster in 2022 after the standards were set very high last year. According to Jeffries analyst Ken Usdin: “At first glance seemed slightly negative, but not a major surprise given a stronger macroeconomic backdrop vs. ’21.”
In my opinion, the erosion of outstanding debt due to the high levels of inflation that have been present over the past year could tarnish overall Tier 1 capital, while volatility in the equity market could provide issues to the Tier 1 Equity Capital requirement.
The Federal Reserve is also expected to take a more holistic view of big bank operations this year. According to Richard Ramsden of Goldman Sachs: “The Fed appears to be putting more stress on all components of the test, from markets to corporates and consumers.”
Worrisome Valuation
Banking stocks generally trade with a negative correlation to their price/book values. It’s generally accepted that when a stock drifts above a price/book value of 1.00 that it’s overvalued. Bank of America stock is trading at a price/book value of 1.5x, which is ~31% higher than its five-year average and 20% higher than the sector average.
Wall Street’s Take
Turning to Wall Street, Bank of America has a Moderate Buy consensus rating, based on 13 Buys, five Holds, and two Sells assigned in the past three months.
The average Bank of America price target of $52.58 implies 14.4% upside potential.
Concluding Thoughts
Investors should be cautious of simply jumping into banking stocks purely because of the rising rate environment. Bank of America is an overvalued stock with severe income statement struggles. I’m not implying that the stock will perform poorly in 2022, but I suggest that investors manage their expectations.
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