Is The Reward-To-Risk Combination Appealing Right Now?

Investors have had more than enough time to price an enhancement of BAC’s ROE into the bank’s shares. In the last six months we have seen exactly that: Trump’s push for lower corporate taxes and less regulation has fueled increased interest in financials, but the point is here is that share prices have already run ahead of fundamentals. 

Improvements in the bank’s ROE have and are already reflected in the bank’s higher valuation in my opinion, and the reward-to-risk ratio is no longer as compelling as it was just six months ago when we added BAC to our portfolio.

In Conclusion

Price action matters, and so does fading confidence in the sustainability of the Trump rally. The point here is that downside risks are growing, but most investors are only thinking about and looking at the rate of price appreciation in the last several months and believe it is sustainable. This is a MASSIVE red flag. If Republicans continue to fail to make significant legislative gains and cannot deliver on Trump’s campaign promises, confidence in stocks will take a hit, thereby making an investment in the entire sector much less appealing.

Can Bank of America’s share price double?

We never say never but in reality it would be a very long shot. It could happen in the best case scenario and even so it will take many years and only under the conditions that :

1. Republicans deliver legislative results (tax and regulatory reform);

2. The Federal Reserve significantly lifts rates;

3. Bank of America’s business runs flawlessly.

Taking into account that Bank of America already sells at book value, I continue to think that upside is more limited than what too many shareholders are prepared to acknowledge. Tread carefully!

Can Bank of America Really Be A Double?

• Bank of America’s shares have already soared since Election Day.
• The question we are asking ourselves, is whether the reward-to-risk ratio is still favorable at today’s price point.
• There are certainly earnings tailwinds looming around the corner, but investors have already priced higher earnings and a higher ROE into BAC’s shares.
• I continue to think that it is time to be cautious.

Bank of America’s (NYSE:BAC) shares have had an tremendous run since the U.S. presidential election. With the PPS up 40 percent since November and since investors have already started to price significant Net Interest Income gains into Bank of America’s shares. So we ask what is the possibility they can run up even higher or it is time to be cautious?

As clients know, we have sold about half of our position in BAC this year as the price soared.   The run up in in price has been fueled by short-term interest rate hikes and a better investment climate after Trump’s surprise election victory. A surge in pro-business sentiment as well as expectations of more interest rate hikes in 2017 have sent financials to new highs recently, including BAC:

The bank’s shares hit a new 52 week high at the start of March ($25.80), but have dropped lately on the back of profit taking and concerns over the sustainability of the Trump rally in light of failed Republican efforts to push legislative reforms through Congress.