Banking on Bank of America

 | Jul 30, 2014 | 1:30 PM EDT
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The last five years or so have been interesting for the banking industry; I describe it as a tale of two extremes. In 2009, financials were loathed, cast as the villains of the Great Recession. Today, financials are experiencing an impressive change in investor perception and financial performance -- except for Bank of America (BAC).

While BofA has clearly made tremendous progress over the past five years, Wall Street continues to discount the bank relative to its peers. Wells Fargo (WFC) is clearly an extreme case, and I would not suggest that Wells and BofA have similar valuations. Wells essentially went through the financial crisis unscathed, having picked up Wachovia for a song. Today, Wells is valued at 1.7x book value, while BofA is being valued at 0.7x book. A similar valuation would imply a nearly 130% increase in the value of BofA shares.

That said, BofA shares closed Monday at $15.50 per share, approximately 10x forward earnings. The company is not yet paying the type of dividend it is capable of paying. Over time, BofA could easily pay $1 per share, which, at today's price, would imply a yield of more than 6%. So, even if BofA paid out $0.50 a share, the yield is more than 3%.

Furthermore, BofA's earning engine is being restricted by settlements and the continued run-off of bad assets. The company is getting very close to closing the book on that forgettable part of its business and when it does -- and I believe it's merely a matter of when, not if -- the true earnings potential of BofA will be appreciated.

Analysts estimate that Bank of America will earn $1.79 per share in 2015. That implies BofA is trading for less than 9x 2015 earnings estimates. I believe that estimate gives little credit for the true earnings potential at BofA. With more than $1 trillion in deposits, BofA has the ability to grow its interest income significantly. Also, if interest rates do start to move higher, BofA will earn more on its assets/loans than it will have to pay on its liabilities/deposits.

Finally, BofA is working diligently to rid itself of "one-time" expenses, such as settlements and legal disputes. As those numbers start to run off the income statement, the earnings potential in the next several years could significantly increase from 2015 assumptions. Fast forward to three to five years from now and BofA could be a $30 to $40 stock.

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