Is it Worth Making an Active Bet on Bank of America?



Benchmarking Bank of America’s Performance

The primary reason for investing in a stock over a given benchmark—engaging in active investing as opposed to merely replicating a benchmark portfolio—is to earn excess returns. In the case of Passport Capital, Bank of America (BAC) was added to its portfolio because the fund expects BAC to generate returns that are superior to the benchmarks listed in the table below.

As observed in the table above, BAC has performed poorly during the year, generating -10.68% returns to its shareholders so far in 2015. While the financial services sector in general—as measured by XLF—has lagged behind the overall market, BAC has suffered more. Its earnings have been squeezed by litigation-related expenses and its asset portfolio, which depends to a greater degree on higher interest rates, has so far generated suboptimal earnings.

Article continues below advertisement

Is the gamble worth it?

The underperformance trend still holds when BAC is compared to its peers Citigroup (C), Wells Fargo (WFC), and J.P. Morgan (JPM), which have respectively returned -1.39%, 2.28%, and 4.19% over the same period.

From a valuation standpoint, BAC trades at 0.8x its price-to-book value ratio, which translates into a 30% discount to that of the peer group average. The price-to-book value ratio is a commonly used valuation multiple for financial services entities because their financial performance is balance-sheet driven. And, when adjusting price-to-book for returns to shareholders, BAC trades at a premium of 42%.

It may appear that investing in BAC is an inferior strategy to taking a more passive stance. But given that BAC stands to benefit most from a long overdue rate hike, Passport Capital’s trade doesn’t seem ill-timed.


More From Market Realist