Seneca Park Research published an article
recently suggesting that Bank of America’s shares have significant
upside potential. In fact, Seneca Analysts argued that the stock had
upside up to $45.
They wrote:
“Importantly, an investor’s returns will be supercharged by the company’s share buybacks. This may reduce the company’s outstanding shares at attractive levels and significantly enhance fair value in our investment time horizon. Assume a 13% ROE and factor in the growth in book value from profits over the next 2-3 years, and we could easily see a company with book value above $30 (up from $24 today) trading at a 1.5x book multiple or better, equaling at least $45 per share.”
This all might sound good in theory and like they are doing solid research, I think there is a fundamental flaw in the analysis. What they are assuming here, essentially, is that the bank will be able (and should) buy back a significant amount of shares, and that such share buybacks will cause further price appreciation. Share buybacks only make sense if the company’s shares are significantly undervalued.
For financial firms, this is the case if their shares sell for a price below accounting book value. Therefore, a bank that buys back shares below book value fuels book value per-share growth, justifying a higher multiple on its earnings.
In other words, buybacks make sense when shares sell for a price below book value, but don’t make as much sense when they sell for a premium. In the case of Bank of America, shares are already selling for about book value and that makes the prospect of buybacks much less attractive from a capital allocation point of view.
“Importantly, an investor’s returns will be supercharged by the company’s share buybacks. This may reduce the company’s outstanding shares at attractive levels and significantly enhance fair value in our investment time horizon. Assume a 13% ROE and factor in the growth in book value from profits over the next 2-3 years, and we could easily see a company with book value above $30 (up from $24 today) trading at a 1.5x book multiple or better, equaling at least $45 per share.”
This all might sound good in theory and like they are doing solid research, I think there is a fundamental flaw in the analysis. What they are assuming here, essentially, is that the bank will be able (and should) buy back a significant amount of shares, and that such share buybacks will cause further price appreciation. Share buybacks only make sense if the company’s shares are significantly undervalued.
For financial firms, this is the case if their shares sell for a price below accounting book value. Therefore, a bank that buys back shares below book value fuels book value per-share growth, justifying a higher multiple on its earnings.
In other words, buybacks make sense when shares sell for a price below book value, but don’t make as much sense when they sell for a premium. In the case of Bank of America, shares are already selling for about book value and that makes the prospect of buybacks much less attractive from a capital allocation point of view.
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