【2024.10】Buffett has been continuously reducing his shareholding. Will Bank of America withstand the pressure? Long-term performance is key!

Counting Buffett's favorites, the Bank of America, which was once the second largest holding stock of Berkshire Hathaway, may be one of them. However, there is no eternal love in the capital markets. Since entering 2024, Buffett has significantly reduced his stock holdings, after cutting Apple in half, he has turned his sights back to $Bank of America (BAC.US)$ , accumulating billions of dollars in share sales, causing him to drop a spot in Berkshire's holdings ranking.

Buffett's reduction trend is undoubtedly one of the market indicators, and it also put Bank of America's stock price to the test, and it once experienced a short-term decline. However, the long-term stock price trend of Bank of America may also depend on its performance trend. On October 15, Bank of America will release its latest results. Every time a company releases results, it may also mean a good transaction or investment opportunity. Before that, investors need to figure out how to understand its performance.

What do you think of Bank of America’s performance? What aspects do we need to focus on in terms of performance? Let’s mainly look at three key points: performance growth, risk indicators and shareholder buybacks,

1. Performance stability

Like most bank stocks, Bank of America's performance overall remains relatively stable and fluctuates slightly with changes in the economic cycle.

From a revenue perspective, taking the last 10 years as an example, Bank of America's revenue has been on a fluctuating upward trend, rising from $88.94 billion in 2013 to $98.58 billion in 2023, an increase of only about 10% over the decade, showing a steady performance.

From the perspective of net profit, Bank of America's net profit increased from $10.08 billion in 2013 to $24.87 billion in 2023, roughly 1.5 times growth over the decade, showing a decent growth rate. During this period, Bank of America's net profit level can mainly be divided into two phases.

During the period of 2013-2018, the level of profit margin continued to rise for higher-profit-interest income while the profit margin for lower-profit non-interest income remained relatively stable. Despite not much revenue growth, due to the overall increase in profit margin, Bank of America's net profit saw a significant increase, reaching $26.7 billion in 2018.

During the period of 2019-2023, Bank of America's net profit fluctuated due to factors such as income tax or provisions for loan losses, but overall tended to be stable, remaining around $25 billion for most of the time.

Bank of America's revenue and profit have been able to remain relatively stable in recent years, largely due to the offset between the two major business modules of net interest income and non-interest income.

During the Fed's interest rate cut cycle, Bank of America's net interest income may decrease, but for the financial markets, a rate cut cycle implies ample liquidity, making market trading more active, thereby likely boosting Bank of America's trading fees and revenue from asset management business.

Conversely, during a rate hike cycle, it is a significant positive for Bank of America's interest income, but rate hikes will impact the financial markets, potentially leading to a decrease in the non-interest income sector.

In recent quarters, as the interest rate hike cycle ended and expectations of rate cuts gradually increased, Bank of America's interest income was difficult to increase. However, deposit costs have risen, resulting in three consecutive quarters of year-on-year decline in net interest income, while non-interest income has remained stable or shown growth in the last two quarters. Currently, quarterly revenue remains near a new high for nearly 3 years.

In the upcoming quarters, with the Fed opening the door to rate cuts in September, Bank of America's net interest income may also gradually face challenges. However, despite short-term uncertainties about performance, our focus of observation may still be on its long-term performance trend. If Bank of America's performance can maintain a steady historical trend, investors may not need to worry too much. If its performance shows consecutive years of decline, the certainty of its investment may be questioned.

2. Changes in risk indicators.

The business model of banks essentially revolves around earning interest spreads, by absorbing money from depositors at low interest rates and then lending it out at higher rates. Therefore, banks have very little equity capital relative to total assets, resulting in a very high leverage ratio. For example, Bank of America's asset-liability ratio in the latest quarter reached as high as 90.8%, a level of indebtedness that is hard to imagine in most industries, but quite common in the banking sector.

The high leverage of banks brings potential high risks, and banks are one of the important cornerstones of the financial system. Once banks collapse on a large scale, the entire financial market will be in turmoil. Therefore, regulatory institutions have set some hard requirements on some financial indicators of banks.

The first indicator is the Common Equity Tier 1 (CET1) Capital Ratio, which is a key indicator of bank financial soundness, used to measure the proportion between the bank's common equity (common stock plus retained earnings) and its risk assets. This is a regulatory indicator set by the Basel Committee on Banking Supervision, with the minimum required CET1 Capital Ratio of around 4.5%. In addition, banks in different countries may also have additional requirements for capital buffers, but generally not exceeding 11%.

In Q2 2024, Bank of America's core capital adequacy ratio is around 11.9%, significantly higher than the requirements of the Basel agreement, and exceeds regulatory requirements for other banks.

The second indicator is the non-performing loan ratio, which is the ratio of non-performing loans to total loans, also an indicator of loan asset quality. Generally, loans that are overdue for more than 90 days may be defined as non-performing loans, the more of these loans, the more potential bad debts and larger potential losses for banks.

In Q2 2024, the non-performing loan ratio in the United States is approximately 0.52%, which is relatively low in the banking industry, indicating good loan quality.

The third indicator is the provision coverage ratio, which is the ratio of funds reserved by the bank for non-performing loans to the amount of non-performing loans, representing the extent to which the bank covers potential losses. The higher this ratio, the more attention the bank pays to potential loan loss risks and the more stable the operation.

Bank of America had a provision coverage ratio of about 240% in Q2 2024, reserving enough credit loss reserves for potential loan losses, which is relatively prudent.

For future earnings reports, we can continue to monitor Bank of America's risk supervision indicators such as Tier 1 capital adequacy ratio, non-performing loan ratio, provision coverage ratio, etc., to see if it can continue to maintain low financial risks. If continuous adverse changes occur, it may require caution.

3. Stability of shareholder returns

Overall, Bank of America's performance has not shown much growth, which may not be very attractive to investors who value company growth. However, from the perspective of shareholder returns, Bank of America may still attract some investor attention.

Public companies generally reflect shareholder returns in two aspects: dividends and buybacks. Among them, dividends are the most direct way to reward shareholders, while buybacks can increase the company's return on equity and earnings per share, inject additional liquidity into the market, and are very popular among shareholders.

Compared to many US-listed companies, Bank of America's historical shareholder returns can be said to be very generous. From 2013 to 2023, Bank of America's cumulative dividends were approximately $63.7 billion, cumulative buybacks were about $115.2 billion, and the total net profit during the period was about $211.7 billion. The total amount of dividends and buybacks accounted for 85% of the net profit, which is quite good in the US stock market.

However, in 2022-2023, this ratio was only 50%, which is a significant difference from the over 100% shareholder return ratio in previous years. Fortunately, in the first half of 2024, this ratio has returned to about 85%. In the future, we can observe whether the company can maintain a higher proportion of dividends and buybacks, thereby providing investors with stable shareholder returns.

Seeing this, you may have some new insights on how to read Bank of America's performance. It is worth mentioning that every earnings release of many star companies may represent a rare trading opportunity for different types of investors.

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Conversely, if investors believe that the latest performance of a certain company will not be optimistic and will bring pressure on the short-term stock price, investors may consider short selling, which can be done by considering margin selling or buying put options.

Of course, if investors think that the bullish and bearish direction of a company's performance is unclear, but the stock price may experience significant fluctuations after the performance release, then investors may consider the straddle strategy of buying call and put options to capture potential opportunities.

Finally, to summarize,

For the performance of Bank of America, we can focus on its performance stability, changes in risk indicators, and the stability of shareholder returns.

In terms of performance stability, Bank of America's past overall revenue fluctuations have been small, and net profit has also been relatively stable in recent years. We can closely observe whether it can maintain long-term performance stability in the face of interest rate cuts.

In terms of risk indicators, we can observe whether Bank of America's core capital adequacy ratio, non-performing loan ratio, and reserve coverage ratio can maintain a solid performance in the future.

In terms of shareholder returns, Bank of America's historical dividend and buyback as a percentage of net profit have been relatively high overall. We can observe whether the company can continue to maintain a relatively generous shareholder return in the future.