Bank of America didn't do a good job lately on the public relations front. First it had to announce a material $4 billion error in calculating its regulatory capital, which was not only embarrassing, but also caused the bank to suspend its capital plans. Secondly, the bank continues to battle the Department of Justice about ending its probe into soured mortgage-backed securities.
In order to end the probe and reach a settlement, the bank offered to put $12 billion on the table, a big sum even for deep-pocketed banking giant Bank of America.
All of this is certainly not helping Bank of America's reputation and stock price: A continuously low market valuation as evidenced by a persistent 23% discount to book value shows, that investors still avoid the bank as an investment.
While news about looming big-time settlements and suspended capital plans do not do their part to convince investors of Bank of America's underlying value, it often helps to take a step back and look at the bank's valuation from an unemotional point of view.
Headline risk, such as the admission of the accounting error which sent shares of Bank of America lower by 6% on the day the mistake was announced, is inherently short-term.
Short-term noise often clouds the underlying value of a company and Bank of America certainly has received more than its fair share of headline risk.
Legal troubles and settlements have weighed down Bank of America for a long time, but a look at Bank of America's historical valuation should give investors a good feel as to what a more appropriate market valuation for the bank might be if conditions normalize.
Bank of America has been trading at substantial discounts to book value since the financial crisis unfolded in 2008. After a short period of recovery in 2010 and 2011, its book value discount actually increased again in 2012 when the bank faced renewed litigation risk with respect to its Countrywide acquisition in 2008.
Investors ultimately ran for the hills and dropped shares of Bank of America like hot potatoes causing shares to trade at a whopping 70% discount to book value in 2012.
Looking at Bank of America's P/B valuation over an extended period of time, however, shows, that the bank has historically traded at a price to book value of 2x or more in periods of market exuberance (2006-2007).
And there is no reason why Bank of America wouldn't be able to achieve a similar valuation three or four years down the line when litigation issues have been resolved, its asset quality has been further improved and the company has been going full in on growth.
Just about last year, in August 2013, renowned bank analyst Dick Bove went on record and said "it is not very difficult for a bank stock in normal times to sell at two times book value. There are virtually no banks in the United States selling at two times book value."
Normal times are still not here yet, but there is a decent chance, that Bank of America's book value will mean-revert in the future.
Nevertheless, short-term risks persist for Bank of America. Especially with respect to litigation expenses and potential settlement, Bank of America could deliver some unwanted surprises in 2014, which could put further pressure on its stock price.
So far, Bank of America's shares have lost 1% in 2014, but gained about 10% since their May 2014 lows.
The Foolish Bottom Line
Bank of America has historically traded at much higher P/B ratios than the current book multiple of 0.77x and a return to the 2x region in a better operating environment is reasonable.
Even though the bank has recovered a lot of ground since it was once again thrown under the bus in 2012, its book valuation is still relatively low compared to its book valuation before the financial crisis.
With a resurging U.S. economy, Bank of America should be able to benefit from cyclically peaking bank earnings and fetch a materially higher price to book valuation as investors' focus shifts from litigation troubles to growth and multiple expansion.
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The article Could Bank of America Really Trade Again at 2 Times Book Value? originally appeared on Fool.com.Kingkarn Amjaroen owns shares of Bank of America. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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