America’s second-largest bank and Warren Buffett’s third-largest holding seems like a no-brainer.
You might know Bank of America (BAC 0.28%) as one of the world’s largest financial institutions. It is a well-known consumer-facing bank with over $3.2 trillion in assets today. You might also know it for the controversial bailout money it and its peers received following the financial crisis of 2007-2008.
You might also associate Bank of America with famous investor Warren Buffett, who has owned stock in it through Berkshire Hathaway for years. Bank of America is Berkshire’s third-largest holding, accounting for approximately 12% of its portfolio.
Either way, many people (including myself) invest in the companies they know, making Bank of America a hot topic. It probably doesn’t need to be said that Bank of America is a get-rich-quick stock. The company is already huge, with a $350 billion market cap today.
But can Bank of America make you rich slowly? Can it compound for decades, potentially making you a millionaire over the course of your investing life?
The boom-and-bust nature of the big banks
A bank’s business is simple at first glance. A bank pays you interest on the money you deposit. The bank takes your money and loans it to someone else at a higher interest rate. The bank makes money (net interest income) from the difference between the interest they earn on the loan and what they pay on deposits.
Big banks, such as Bank of America, are far more complex. They touch almost every aspect of the economy, including personal and business banking, mortgages, student loans, commercial real estate, and the financial markets. Banks can be very lucrative when the economy is firing on all cylinders, and people and businesses borrow a lot.
But it goes the other way, too. When something goes wrong in the financial markets or the economy, it usually affects the banks. Remember the housing crash and financial crisis of 2007-2008? It was partially due to a bubble in subprime mortgages — to which, you guessed it, Bank of America and other big banks had major exposure. Their heavy losses prompted financial intervention from the government.
The U.S. economy is a juggernaut over the long term, but sometimes, things break for one reason or another. When this happens, Bank of America and its peers tend to feel it, too. It comes with the territory of being so deeply ingrained in the world’s largest economy. This creates a boom-and-bust nature for big banks, and their size and notoriety can sometimes make them a regulatory target.
Banking meltdowns eat into the stock’s long-term performance
Over time, the occasional crisis or recession has dragged Bank of America stock down.
In the chart below, you can see that Bank of America’s 2008-2009 crash wiped out decades of investment returns. Most bank stock downturns aren’t that severe, but Bank of America stock is no stranger to sharp declines. Sometimes, it can take several years to recover.
BAC Total Return Price data by YCharts.
Even today, there are potential risks. Rising interest rates have piled $108 billion in unrealized losses on hold-to-maturity securities onto Bank of America’s balance sheet. Now, as long as nothing forces Bank of America to touch those securities, it won’t have to realize those losses. Eventually, those loans will mature harmlessly.
Still, investors shouldn’t completely dismiss the risk. Who knows what might happen in the future? Who foresaw a global pandemic in 2020?
Can Bank of America make you a millionaire?
Bank of America has been a fantastic stock for Warren Buffett since he invested in 2011. But as great as Buffett is, don’t buy Bank of America simply because he did. Warren Buffett struck a unique deal for preferred stock and warrants during a time of need for the big bank. It’s not the same as buying common stock on the open market today. Berkshire has trimmed its stake in the company over the past year, though Bank of America remains a core holding.
The lesson? Don’t buy (or sell) based solely on someone else’s actions, even those of a legend like Buffett.
There’s a lot to like in Bank of America. It’s still one of the world’s largest banks and will likely keep growing alongside the U.S. economy. Analysts expect roughly 10% annualized earnings growth over the next three to five years. The company pays a stable dividend that yields 2.2% today, making it a solid holding in a diversified portfolio. And, if you bought and held through all the ups and downs, the stock has returned over 3,000% since the early 1970s.
But a millionaire-maker today? Probably not. Big banks are too prone to disaster, and Bank of America is too large and mature now to deliver the explosive growth you’d need for life-changing investment returns anytime soon.
Bank of America is an advertising partner of Motley Fool Money. Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bank of America and Berkshire Hathaway. The Motley Fool has a disclosure policy.