Author: Bristlecone Value Partners
Covestor model: Large Cap Value
Disclosures: Long HOG, APOL, DELL, S, CSCO, LINTA, BAC
In June, the model portfolio declined by 1.7%, slightly beating the S&P 500 index’s -1.8% return according to Covestor calculations, as investors appeared to be spooked by developments in Greece. Year-to-date through end of day June 30, the model portfolio is up 7.25% versus a 5% gain for the S&P 500 index.
Top contributors to performance were Harley Davidson (NYSE: HOG), Apollo Group (NASDAQ: APOL), and Dell (NASDAQ: DELL). The top detractors were Sprint Nextel (NYSE: S), Cisco (NASDAQ: CSCO), and Liberty Media Interactive (NASDAQ: LINTA).
We did not sell nor reduce any position during the month, but we initiated an investment in Bank of America (NYSE: BAC). As we’ve said in the past, companies that are experiencing financial troubles can sometimes offer great potential to patient investors.
Following the acquisitions of Countrywide and Merrill Lynch, Bank of America became ensnared by the mortgage crisis to a much greater extent than its main competitors. Its portfolio of loans experienced higher default rates, and it is fighting more lawsuits from disgruntled investors in mortgage securities.
Investing in a situation like Bank of America requires looking down the road and estimating the company’s earnings power and its ability to absorb further loan losses. In our view, despite some poor capital allocation decisions, the company retains a very valuable banking franchise with strong competitive advantages. Making what we feel are conservative assumptions, we believe that Bank of America’s normalized earnings power two or three years out will exceed $2.00 per share.
The biggest risk is that actual loan losses and legal costs over the next 12 to 18 months significantly exceed our projections. We ran a downside analysis in order to estimate the level that would require Bank of America to raise additional capital. Not only do we view the probability of such a scenario as relatively low, but we also feel that with the stock trading at a discount to tangible book and mid-single digit multiple to normalized earnings, the current share price is already discounting some of the worst case scenarios.
We definitely do not expect a smooth ride, but we think that our investment in Bank of America presents strong potential over the next two to three years.
Sources:
Yahoo Finance, 7/14. http://finance.yahoo.com
