Why Is Bank of America Corp (BAC) So Cheap?

Love it or hate it, Bank of America Corp (NYSE:BAC) is an impressive operation to behold. To mention only the most notable figures, its balance sheet contains $2.2 trillion in assets and the lender is entrusted with more than $1 trillion worth of the nation’s deposits. At the same time, however, its stock trades for a significant discount to that of its competitors. What gives?

Valuing bank stocks
When it comes to valuation, bank stocks are in a category of their own. Most equities trade for a multiple of earnings, represented by the price-to-earnings ratio. The belief is that, as owners of a company, shareholders are entitled to its profits. Profits drive return on investment. Consequently, the goal is to get the most bang for your buck in terms of earnings.

And that’s exactly what the P/E ratio represents. On the low end, a ratio of five means you’re paying $5 for every $1 in earnings. On the high end, a ratio of 100 means you’re paying $100 for every $1 in earnings. This metric normalizes valuations both within particular industries and across the broader market.

Unless you’re talking about bank stocks, that is. As opposed to a multiple of earnings, the measuring stick used here is book value per share — and tangible book value per share more specifically, which removes intangible assets such as goodwill from the equation. This is derived by subtracting all of a bank’s liabilities from its assets. It’s the same thing as a bank’s equity.

With this in mind, it’s natural to assume that most banks would trade for no less than tangible book value. Think about it. Why would a bank trade for less than it’s objectively worth?

This is where Bank of America comes in. As you can see below, along with Citigroup Inc. (NYSE:C), it’s the only other too-big-to-fail lender that trades for less than this seemingly concrete figure. Meanwhile banks like JPMorgan Chase & Co. (NYSE:JPM), Wells Fargo & Company (NYSE:WFC), and particularly U.S. Bancorp (NYSE:USB) trade for healthy premiums to their valuations.

Source: S&P’s Capital IQ.

Here’s the catch. While a measure like tangible book value may seem objective and concrete, the reality couldn’t be further from the truth. This is because many of the asset values on a bank’s balance sheet are themselves subjectively determined. There are certain complicated derivatives, for instance, that aren’t traded, and thus priced, on public exchanges every day. It’s left to the bank’s management to figure out what these are worth.