Is Bank of America Doomed or a Value Investment?

Even though it is one of the most reviled companies in America, Bank of America (NYSE: BAC) is widely viewed as a value investment. Warren Buffett famously holds a large stake in the company, also known as BOA, and it is easy to see why.

Bank of America reported $15.89 billion in income for the fourth quarter of 2015, yet its shares were trading at just $13.11 on March 9, 2016. The bank also reported a TTM revenue of $82.15 billion, a profit margin of 14.61% and a free cash flow of $6.15 billion for the fourth quarter.

Yet it is one of the most undervalued financial institutions around. On March 9, 2016, BOA had a market capitalization of $135.32 billion and an enterprise value of $254.89 billion.

Is Buffett Right about Bank of America?

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Investors such as Uncle Warren were rewarded with a dividend yield of 1.53% and a return on equity of 6.91%, meaning that there is little to risk in owning Bank of America stock but a lot of upside to it.

More importantly, Bank of America is still a company with a lot of cash; it had cash and short-term investments of $167.1 billion during the fourth quarter. To add icing to the cake, BOA reported $48.58 billion in cash and short-term investments and $27.37 billion cash from operations.

Persons looking for a cheap company that has a lot of cash will be well served by Bank of America. Despite its lousy reputation as one of those monster banks that Americans love to hate, it generates a lot of cash and repays investors.

Shrinking Revenue at Bank of America

Yet there are some clouds on the horizon because of dismal revenue growth. The real problem facing Bank of America and its competitors is falling revenues. The revenue drops at BOA are not as bad as in past years, but they are still worrying.

In December 2013 Bank of America reported a TTM revenue of $88.94 billion that fell to $84.25 billion in December 2014 and $82.51 billion in December 2016. Even though BOA is still flush with cash, its revenues are shrinking.

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Interestingly enough, this is not affecting income. Bank of America reported $4.833 billion in revenue in December 2014 and $15.89 billion in revenue a year later. Yet it is affecting cash flow; Bank of America reported $30.14 billion in cash from operations in December 2014 that fell to $27.73 billion a year later. The cash from operations is a bothersome figure because as recently as December 2013 it reported $92.82 billion in cash from operations.

This seems to indicate that the bank’s basic business is falling off. It may no longer be able to generate large amounts of cash from consumer banking activities, such as checking accounts and mortgages.

Why Is Bank of America’s Business Declining?

There are a number of reasons why Bank of America’s business is shrinking, all of which investors need to pay close attention to. Some of the factors eating away at Bank of America’s income include:

  • The average household income in 81% of the counties in the United States has not increased or has actually fallen since 1999, just before the turn of the 21st Century, The Washington Post reported in 2014. That means Bank of America’s middle-class customers simply have less money for consumer loans and mortgages and less cash to run through their bank accounts.

 

  • Housing costs are rising. The average family making a typical income cannot afford to buy a home in 13 major U.S. cities. This discourages home ownership and mortgages, which are one of Bank of America’s main businesses. Many working and middle-class families now view home ownership as an unaffordable dream.

 

  • Car ownership is in decline, which means fewer auto loans. The average household no longer owns two cars, The Atlantic reported in 2013, while the number of people under 25 with driver’s licenses fell sharply, The Wall Street Journal reported in January 2015.

 

  • More Americans are seeking alternatives to traditional banks. Credit union membership in the United States reached 101 million for the first time during the second quarter of 2015, Credit Union Times Statistics from the National Credit Union Association indicate that membership in the alternative financial institutions has been growing at a rate of around one million a year.

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  • Americans are joining credit unions because many of them no longer trust traditional banks. The roots of this distrust include the Great Financial Meltdown of 2007 to 2008, political attacks on banks and unpleasant experiences with some banks.

 

  • Many Americans are using alternative financial products such as digital wallets like PayPal, Venmo and Apple Pay, online banking and payday lending. These products are often cheaper and more flexible than traditional banking processes.

 

  • More people are using online banks such as of Bank of Internet (NASDAQ: BOFI), EverBank (NYSE: EVER) and Capital One 360. The institutions increasingly attract investors with perks such as free ATM withdrawals.

 

  • People are simply using physical banks less because of decreased use of cash and increased Internet banking. There simply is little or no reason for an average person to go into a bank these days. Many banking services, including cash withdrawals, are actually available at the registers in many supermarkets and retailers such as Walmart. This provides less incentive to join a bank with a lot of branches, such as Bank of America. This trend will accelerate as the use of digital wallets increases and cash declines. Only around 40% of the purchases in the U.S. are made with cash.

 

  • More Americans are taking advantage of alternative lenders such as Prosper and Lending Club (NYSE: LC), which are more flexible than many banks. Younger people, for example, are more likely to go to an online lender such as Lending Tree (NASDAQ: LT) for a mortgage than a bank.

 

All this indicates that Bank of America and the other big monster banks, such as JPMorgan Chase (NYSE: JPM), are going to have to radically change their business models or face massive revenue losses. BOA is already doing this by trying to integrate its vast ATM network with digital wallets such as Apple Pay. Not to be outdone, Chase is developing its own digital wallet called Chase Pay.

Bank of America and its peers certainly have the resources to adapt to the changing times. The question facing investors is, can they adapt fast enough before their business drops dramatically? Since such institutions often move at a glacial pace, they might not be able to evolve with the times.

Despite that, Bank of America is still a really good investment because it is so cheap right now. If you are looking for a low-cost financial industry play or a value bargain, Bank of America is for you.

Disclosure: the Blogger owns shares of Bank of America and PayPal Holdings Inc.