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Why I'm in No Hurry to Buy Bank of America Stock

Motley Fool - Tue May 16, 10:27AM CDT

My preference is to buy well-run companies when they are offering historically high dividend yields. It's inherently a value approach that takes advantage of Mr. Market's frequent emotional whims.

Right now, Bank of America(NYSE: BAC) is on my radar screen after the bank failures in early 2023. While I see the opportunity the mini-banking crisis earlier this year created, I'm happy to stick with my investment in Toronto-Dominion Bank(NYSE: TD).

What's gone wrong

Whenever I see a company that I believe is well run but has a historically high yield, the first question I ask is, "Why?" Sometimes a stock is cheap for a reason because there are major problems that won't be easily solved, and the stock is best avoided.

That does not seem to be the case with Bank of America, which is a financially strong U.S. bank. It looks like it is simply getting tarred by the negative sentiment caused by the high-profile failures of some smaller banks. In fact, Bank of America appears to have benefited from the troubles, as customers increased the amount of cash they have deposited in the bank.

A pair of sneaker with arrows in front of them indicating options or alternatives choices.

Image source: Getty Images.

There's always a chance that something goes very wrong, but it seems unlikely that Bank of America is materially hurt by the upheaval. So the 45% stock price decline since early 2022, with a big chunk of that taking place in 2023, seems a bit overdone. That drop, meanwhile, pushed the dividend yield up to 3.2%. That is near the highest levels of the past decade for this stock.

It would seem like an ideal candidate for my portfolio, but I'm not ready to bite. For starters, I already own two other banks -- TD Bank and Bank of Nova Scotia(NYSE: BNS). But that's not the real problem.

I like it less

I'm happy to load up on a sector if I find a collection of compelling investments. For example, I own six consumer staples stocks. I just need to believe there's a reason why adding a new name in a sector adds value. I don't think Bank of America does that for me.

For example, while the yield is historically high, I could buy more of either TD Bank or Scotiabank (as the Bank of Nova Scotia is commonly called). They have yields of 4.5% and 6.1%, respectively.

Meanwhile, the overlap between Bank of America and TD Bank would be material, as TD Bank has notable U.S. operations. (Scotiabank's exposure is split between Canada and South America.) In fact, TD Bank, which has a smaller U.S. footprint than Bank of America, probably has greater growth prospects in the U.S. market.

Meanwhile, Bank of America's Tier 1 capital ratio was a respectable 11.4% at the end of the first quarter. Tier 1 ratios give investors an idea of how well a bank can handle adversity, with higher numbers being better. TD Bank's Tier 1 ratio at the end of its fiscal first quarter was 15.5%.

Now, to be fair, TD Bank's ratio is elevated partly because of a planned merger that has since fallen through. But it is still every bit as well prepared for hard times -- perhaps more so -- than Bank of America. (Scotiabank's Tier 1 ratio was 11.5%, for reference.)

Then there's the fact that Bank of America is a U.S.-based bank, and the U.S. faces less banking regulation than the Canadian banking sector. This is not a small issue; Canadian regulations have entrenched TD Bank's Canadian position and created a conservative ethos that permeates its entire business, Canadian and otherwise.

The best example of this was the Great Recession, when Bank of America's risk-taking led to a dividend cut, and TD Bank's more conservative approach meant it was able to maintain its dividend. That's no guarantee that TD Bank won't ever cut its dividend, but it does speak to the culture of each bank.

I'll stick with what I own

I completely understand why investors would want to jump on Bank of America's stock, given its steep (and likely unjustified) price decline and historically high yield. And yet, when I look at the bank compared to what I own, I'm just not finding a compelling reason to own it. I'd much rather put more money into TD Bank, which saw a stock price decline of nearly 30% from its most recent highs.

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Bank of America is an advertising partner of The Ascent, a Motley Fool company. Reuben Gregg Brewer has positions in Bank Of Nova Scotia and Toronto-Dominion Bank. The Motley Fool has positions in and recommends Bank of America. The Motley Fool recommends Bank Of Nova Scotia. The Motley Fool has a disclosure policy.

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