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Surviving Hard Times
With Bank of America, the Flagship of US Banking
Note: My assessments of Bank of America prospects are frequently updated on the Investor Village BAC message board under the alias SargeK. For example, see the September 10, 2008 post: "Bank of America Profit Express" http://www.investorvillage.com/smbd.asp?mb=4352&mn=1768&pt=msg&mid=5570065
During this period of great financial difficulties, individual investors are confronted with almost insurmountable challenges just to maintain purchasing power of their investable dollars after adjustments for taxes and inflation.
The housing bubble, credit/financial crisis, and Federal Reserve Board actions that have lowered returns on Certificates of Deposits has led to confusion among investors, especially senior citizens, who are experiencing higher energy, food and medical expenses while their incomes from savings and investment are in general decline.
Accumulating Wealth
Any strategy for accumulating wealth requires maintaining purchasing power of capital, savings and investment. Disciplined savings regularity and nominal, safe rates of return, above the combined rates of inflation and direct taxes are necessary to achieve real economic freedom and prosperity. Speculation and get rich schemes may work for the lucky few and the truly talented; but average folks are faced with the choice of preserving resources or becoming more dependent on government promises to satisfy future needs.
Widely touted as safe-haven investments, long-term US government debt is not in my opinion a refuge for safety or quality. At best, short-term US debt instruments may be used as a temporary resting place for capital seeking alternative choices to advance future prosperity. With inflation, conservatively measured by the CPI, above 4% and trending up; finding savings/investment vehicles that preserve and/or increase purchasing power is no easy task.
I can’t speak for anyone but myself; but, this is the choice I have made. As CD’s have matured, I began (after considering many alternatives) to accumulate Bank of America (BAC) common stock. The objective has been to find investment(s) that offer the lowest risk with the highest yields and a rational expectation of capital gains, the combination of which may be anticipated to produce higher future income in “real” dollars.
Because of the extreme volatility in financial issues, I have also resorted to some “Day Trading” and moderate use of “Margin” (loans from the broker) to reduce my (per share) costs and increase dividend yields. While it is working for me, it is NOT a practice I recommend to a novice investor.
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Bank of America Corporation (BAC) Dividend Yields
versus CDs and US Treasury Debt Instruments
I selected Bank of America, my personal investment of choice, to serve as an example to compare low risk BAC high yield dividends with other investment alternatives such as Certificates of Deposit (CD), government debt instruments and other equities in the S&P 500.
Bank of America $0.64 quarterly dividend ($2.56 annually) provides a 7.68% yield based on the $33.33 Price Per Share (PPS) closing price on August 1, 2008
http://finance.yahoo.com/q/hp?s=BAC&a=04&b=1&c=1983&d=05&e=3&f=2008&g=v The BAC dividend has an enviable record of increases as the chart demonstrates.
National average 5 year Certificate of Deposit is 4.13%
http://www.bankrate.com/gookeyword/rate/deposits_home.asp
US Treasury 30 Year Bond yield is 4.56% http://finance.yahoo.com/bonds/composite_bond_rates
Average dividend yield of all S&P 500 stocks is an anemic 2.12% http://www.indexarb.com/dividendYieldSortedsp.html
The history of Bank of America and its CEO and Chairman Ken Lewis demonstrates how old-fashioned management has resulted in increasing wealth of the company and its shareholders. See BAC Dividend History.
The history of the US Government and the Federal Reserve banking system demonstrate how flawed fiscal and monetary policies (and perhaps mismanagement of both) have resulted in perpetual, unsustainable debt. See The Legacy of Perpetual Debt
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Another consideration for choosing BAC is that I have been a Bank of America customer for a number of years and have continuously enjoyed friendly, efficient, professional services.
Institutional Selling Influenced by Downgrades
Widespread downgrades of financial equities and analyst recommendations to “Avoid, Sell, Strong Sell, etc.” have resulted in self-fulfilling prophecies. Fear permeates the airways and newsprint and individual investors often respond in a predictable manner. Fiduciary managers of pension funds are also heavily influenced by the ratings agencies. It is easier to explain a sell of an undervalued equity than it is to buy it when it is already oversold because of prevalent negative reports and commentary. My own view is a sudden drop in prices during periods of low volume often represents buying opportunities that can lower price per share in investment portfolios and increase dividend yields.
Careful use of Margin may Facilitate Portfolio Management
The chart illustrates that yields (with a fixed dividend) increase as PPS decreases. With a $2.56 dividend; a $30.00 PPS provides a yield of 8.53%. A PPS of $20.00 provides a yield of 12.8%. Buying shares during a significant “dip” can cause the use of margin to become attractive, if exercised with caution. e.g. Assuming a margin loan interest rate of 7.75%, money can be borrowed against existing shares that may be significantly less than the dividend yield. 12.8% yield minus 7.75% margin costs results in a 5.05% incentive to borrow funds to take advantage of temporary opportunities. As long as the dividend can be maintained or elevated and the margin rate remains fixed; an investor can actually earn money while waiting for the inevitable turn around. This is a very rare financial phenomenon and should be exercised with extreme caution with sufficient reserves set aside to increase bets if the PPS suffers further decline.
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Housing and Economic Recovery Act of 2008
As the nation’s largest originator and servicer of mortgages, Bank of America will be a primary beneficiary of the Housing and Economic Recovery Act of 2008
The decline in house prices coupled with the $7500 tax credit for qualified 1st time home buyers (from April 9, 2008 through June 30, 2009) will IMHO stimulate a lot of renters to take advantage of this rare opportunity. If my assumption proves to be correct; the housing glut may quickly become a shortage and a reversal in prices should not be unexpected. For a general review of basic information authorized by the legislation visit: http://www.federalhousingtaxcredit.com/ The following is a cautionary note extracted from the Q and A at the hyperlink.
“The tax credit must be repaid. Home buyers will be required to repay the credit to the government, without interest, over 15 years or when they sell the house, if there is sufficient capital gain from the sale. For example, a home buyer claiming a $7,500 credit would repay the credit at $500 per year. The home owner does not have to begin making repayments on the credit until two years after the credit is claimed. So if the tax credit is claimed on the 2008 tax return, a $500 payment is not due until the 2010 tax return is filed. If the home owner sold the home, then the remaining credit amount would be due from the profit on the home sale. If there was insufficient profit, then the remaining credit payback would be forgiven.”
There are 36 million renter occupied households in the US, many of whom aspire to own a home. Inflation adjusted wages for average families have stagnated for years and until 2006 prices of houses often rose faster than down payments could be saved. http://www.nmhc.org/Content/ServeContent.cfm?ContentItemID=1152
Because of the short duration of the $7,500 tax credit for 1st Time Home Buyers; those who are qualified and have saved some money for a down payment will be highly motivated to buy now while prices are depressed and a “Buyers Market” exist.
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Estimated Earnings Per Share (EPS) and Price Forecast
August 11,2008
Currently, mean fiscal year annual earnings estimates for Bank of America are:
2008 - $2.45, 2009 - $3.32, 2010 – $4.43 http://phx.corporate-ir.net/phoenix.zhtml?c=71595&p=irol-estimates
The average earnings estimate for 2009 is $3.32 http://finance.yahoo.com/q/ae?s=BAC
The most recent EPS (Jun 2008) was $0.72, 35.8% higher than the $0.53 average EPS estimated by financial forecasters. Since BAC has now had the time to scrutinize Countrywide financials and believes the Countrywide acquisition will add to BAC earnings in 2008; it should not be unexpected that future EPS estimates may be revised upwards. The earnings picture should become significantly more transparent when the 10K quarterly report for 3Q/2008 (that will consolidate B of A/Countrywide financials) is released in October.
On October 1, 2008 $10s of billions of dollars will begin to flow into the national economy as result of the significant reforms contained in the Housing and Economic Recovery Act of 2008.
Summary: http://www.hud.gov/news/recoveryactfaq.cfm Also, a resolution of the lawsuits and investigations of B & A (and Countrywide) might be expected or at least more clarity will evolve so investors can make a more informed choice with regard to Buy, Hold or Sell BAC shares. I believe those issues will be resolved harmoniously among all parties and that B of A will not be heavily penalized for doing what is in the best interest of the economy going forward.
As the largest retail bank in America and the largest originator and servicer of mortgages,. I know of no other entity that will benefit from the housing and mortgage finance legislation than Bank of America.
Based on current earnings estimates and an assumed Price to Earnings Ratio (P/E) of 15, I will not be surprised to see BAC stock prices to rise to $40 by Xmas, $50 in 2009 and $65 in 2010.
As investors become more focused on yields from low risk dividend income and less focused on the “hot” stocks that can just as easily fizzle as skyrocket, prices of quality, high yielding equities will rise. The combination of high yield and potential capital gains of Bank of America offers a rare opportunity for workers planning for retirement, and low risk income for those already retired.
DISCLAIMER
I am not an economist, financial analyst, nor do I hold any degree except experience gained in the school of hard knocks. All opinions are expressly my own and may be biased because I own a large number of BAC shares and I am in the process of accumulating more as additional adverse news emerges that provide the ammo for short sellers, speculators, and highly leveraged hedge funds to drive prices down to even more attractive levels than currently exists.
I do not dismiss the awesome power of that group to temporarily move the prices of commodities and equities to almost any level, they might find profitable. I do not expect another irrational sell-off like the one that recently occurred; but if it does, I will increase my holdings significantly even if I have to resort to the prudent use of low-interest (relative to dividend yields) margin loans to acquire additional shares, as I did recently.
Good luck to all.
John Koraska aka SargeK
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