Buy Like Buffett

I added more shares of Bank of America (BAC) through my DRIP plan today. Shares of Bank of America trade at just $13.46. The stock has been punished due to its lackluster earnings report and the expected negative impact that financial reform may have on BofA’s earnings. Let’s take a look at the pros and cons of investing in Bank of America.

The negatives for Bank of America are as follows:

1) Credit losses continue to rise as delinquency rates are increasing. Bank of America has tremendous exposure to the real estate market and credit card market.

2) Financial reform is expected to put a cap on interchange rates. This would severely impact debit card fee income.

3) Trading revenues dropped substantially after bolstering the bank in Q1.

4) Much of last quarter’s profitability was due to one time gains such as the sales of bank assets.

So, why should you buy the shares?

Bank of America trades at a discount to book value. The bank’s earnings power is still incredibly strong. Fee income could easily offset any future losses. I expect Bank of America to find new ways of generating fee income by charging for services that used to be free. Increased checking account service charges and increased account activity fees.

The large deposit base gives Bank of America the cheapest form of capital. Bank of America has enough cash reserves to weather any economic downturn.

The downside is already baked into the stock’s price. Analysts have been rushing to downgrade shares of BofA. This is a bank that could easily earn $3 a share in in 5 years. Even if Bank of America only earns $2 per share 3 years from now, the stock still only trades at just 6.5 times earnings.

This is definitely not an overnight play. It may take years for things to shake out at Bank of America. However, I think that patient long term investors will be rewarded when the economy rebounds.

Disclosure: I do own shares of Bank of America.

Photo by: taberandrew

Keep an eye on shares of US Steel (X). The stock has dropped to $42 per share. I will be looking to start a position in US Steel in the 30′s. US Steel is currently trading at just 7 times next year’s earnings projections. Even if the company’s 2011 EPS is off by 25%, US Steel would still trade at just 9 times earnings. The stock would be an absolute steal in the 30′s.

Today US Steel (X) reported a loss of 267 million dollars for Q4 of 2009. The $1.65 per share loss was 22 cents below analysts expectations of a loss of $1.44. The big surprise is that US Steel is forecasting a similar loss for Q1 of 2010. The projected loss would be the 5th straight loss for US Steel. The stock has been pummeled dropping over 10% to $50.50 per share today. I listed US Steel in a post last week as one of three stocks that investors should consider selling. I believed that US Steel’s stock valuation was too rich when shares were trading over $65 last week. I received a lot of emails from individuals who said that I was crazy and that the steel giant was only headed upward. Over the past week US Steel has lost 23% of its value and I don’t believe shares have totally bottomed out.

Why did I think US Steel was overvalued? The stock was priced for perfection. Analysts were all over television screens telling investors to buy US Steel despite its hefty PE ratio. Merrill Lynch and Deutsche Bank were adding US Steel to their buy lists when the stock was trading at its 52 week high. The stock was priced for a robust economic recovery, rising steel prices and lower raw material costs. It was obvious that any negative news was going to punish the stock badly. 

So what do I expect now? I expect brokerage firms to change their opinions and place US Steel on their sell lists. The stock is a screaming buy in the upper 20′s but I doubt it will ever get that low. I would actually look at buying shares of US Steel in the high 30′s to mid 40′s now that expectations have been tempered.

Electronic Arts

Electronic Arts has once again disappointed investors. EA downgraded profit expectations from 79 cents to a range of 40 to 55 cents per share. Electronic Arts had more excuses for why the company’s revenue was lagging. Electronic Arts blamed the poor economy, overseas weakness and consumers changing buying habits. I don’t believe that is the case. Wedbush Morgan analyst Michael Pachter said it best. Electronic Arts simply “did not have the products that people wanted” and should be acknowledging that rather than “blaming everything on the environment.” EA looks tempting at $16.74 but after having fallen into that value trap before; I will pass.

Alcoa Swings & Misses

Alcoa reported a profit of 1 cent per share disappointing the street which had expected the aluminum maker to report 6 cents a share. Revenue came in higher than expected at 5.42 billion but the increase was offset by higher operating costs. Alcoa’s stock dropped 5.4% down to $16.51 in after hours trading.

I will be keeping an eye on earnings announcements from Goldman Sachs and Morgan Stanley this week. It should give insight into just how bad things are for financial companies. Goldman currently trades at around $68 and Morgan Stanley at $14. Goldman is expected to report its first quarterly loss in 70 years. Analysts think that losses may be high as $5 a share. If earnings are worse than expected there will be a major sell off of financial stocks which may represent a buying opportunity.