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By Shannon Zimmerman | 11-06-2012 03:00 PM

Nygren: Double-Digit Earnings Growth Possible for B of A

Bank of America's current management team has allowed the firm to have possibly the strongest capital position among major U.S. banks, says Oakmark's Bill Nygren.

Shannon Zimmerman: Bank of America is a company that had been in each of your funds, Oakmark and Oakmark Select. Was it ever in Global Select?

Bill Nygren: Yes, it was.

Zimmerman: So at Oakmark Select, it's been out for about a year. And now in the third quarter of this year, it has come back in, in a pretty big way. It's a top five position, I think, at Oakmark Select, about a 5% position. Talk a little bit about your thinking getting back into that company given the sort of regulatory overhang over the industry in general and Bank of America in particular. But then also given how valuation-conscious you are, the trajectory of the stock price has had pretty nice runup over the first part of the year and you entered in the third quarter even though Oakmark requires a pretty substantial discount to intrinsic value to make into a portfolio. What changed about your thinking that made you think that this company is deeply underpriced?

Nygren: I wish every time we sold a stock, it was because the valuation had gotten up to the level we thought it would get to. Unfortunately, we also sell when companies aren’t following the fundamental path that we were expecting.

When we sold Bank of America that was more the issue. It was not that the stock price had gotten too high, but it was the capital base that the company had was not standing up to the ever-increasing demands the government was making for capital.

We feared that there was more potential for shareholder dilution, which has been a very significant negative across the financial-services sector over the past four years. Over the ensuing year Bank of America did a good job of shedding assets--some through sales, some through maturities of securities that they owned--and they've actually gotten to a point now where their capital position is just about the strongest among the major U.S. banks.

We no longer had the fear that it was going to be years longer before Bank of America could return capital to shareholders. They've got a management team in place that is no longer the old acquisitive Bank of America management team where you could really question whether or not value was added for the shareholders. But this management team is very oriented toward return of capital, and the company has got a tangible book value of about $15 a share.

We believe that's a dollar-good number. We see no reason that the company shouldn’t be able to earn at least 10% on its book value. That would be $1.50 or higher in earnings, and the world that most of the bearers on the banking industry are worried about is a world where there is no loan growth. If there is no loan growth and there is no need for capital to continue building up in the business, that's a $1.50 that can be returned to shareholders. A typical bank today is paying out about 30% of its earnings as dividends. So that would be something like a $0.45 or $0.50 dividend on a stock that today is sub-$10.

We don’t see many companies today in the market yielding over 4%, and the company would be using the rest of that capital to repurchase shares. That will be about $1 per share for share repurchase, meaning that it could take out 10% of its shares annually. So even if there is no growth in the basic business, we think earnings per share at Bank of America could still grow at a double-digit rate.

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