Top Value Fund: Bank of America and AIG Too Cheap to Ignore
The Oakmark Select mutual fund just made a big bet on two of the most toxic stocks of the financial crisis. In the third quarter the fund established new positions in Bank of America (BAC) and AIG (AIG) that now account for nearly 9% of the fund’s $3.2 billion in assets.
Both battered stocks are clearly staggering off the mat of late, as seen in a stock chart:
It’s not that managers Bill Nygren and Henry Berghoef are over-the-moon bullish on the growth prospects for either company. Rather, the value managers dove in because they think both stocks are just too damn cheap to pass on.
As Nygren wrote to shareholders: “(W)e believe that these companies’ attractive valuations far outweigh their declining profitability…We’re not claiming that financial services businesses are the highest quality businesses out there. Instead, we’re arguing that their current low multiples of earnings and book value are creating an unusual opportunity”
The Oakmark managers note that pre-crisis, banks and other financial service firms traded at about 2x book value. Right now Bank of America and AIG sell at around 0.5x book value.
The managers aren’t expecting a return to 2x book value. They note that the days of 15% return on equity are long gone for the financial services sector, in part due to the changed regulatory landscape. But they say even at half that rate both firms are trading at a steep discount to their book value. In an interview with Barron’s Nygren noted that if AIG’s stock got back to just 1x book value the share price would be north of $60 a share.
The expectation is that once both companies get their capital requirements squared away they will have lots of excess earnings to deploy elsewhere-and returning capital to shareholders would be at the top of the list. The managers surmised that if all future earnings were excess capital, AIG would be able to repurchase 14% of its shares. Assuming net income didn’t budge that would still be enough for a 16% rise in per-share earnings.
For Bank of America, the managers are banking on a rebound in the dividend payout ratio to 30% in the next few years. If their forecast of $1.50 earnings per share for 2014 pans out that would mean a 5% dividend yield for anyone buying today.
Carla Fried is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.