Bank of America A warrants (2019) were our biggest loser in the quarter and took away from an otherwise strong performance in a difficult quarter. Looking back, we were too early in our timing and size of the position, but remain highly confident in the Bank’s turnaround progress. We also think the warrants have a more attractive risk/return profile compared to the stock due to the implied leverage, long-dated timeframe, and the small-cap profile of the warrants that limits access to smaller funds like ours.
BAC’s earning power is becoming increasingly more visible within the core business units as the quarters go by. Our confidence in the opportunity is rooted in medium-term operational execution progress that is unlocking existing earning power that was otherwise being masked. We think the market has dramatically mispriced the business by making the stock a proxy for the perception of rate hikes and, more recently, oil prices.
We also see a growing competitive advantage and earning power over smaller/regional banks due to BAC’s enormous scale, balance sheet strength, and technology leadership in mass-market consumer banking products. This combination will help drive margin efficiencies, grow profitability, and continue attracting new deposits, even in a low interest rate environment.
At a price of ~10% below tangible book value, and growing 8% – 9% annually, BAC stock is a bargain at $15 per share today. However at $4.30 the A warrants imply a 2019 valuation of ~$17.20 per share for BAC, which grossly undervalues the Bank’s earning power over the next three years.
This post has been excerpted from the JDP Capital Management Q1 2016 Letter to Limited Partners.