Wall Street Releases Earnings: How Can Bank Stocks Rally?

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This week is a huge one for the financial services industry.  In all, four of the nation’s biggest banks report earnings.  JPMorgan Chase (NYSE: JPM) and Goldman Sachs report on Wednesday, Bank of America (NYSE: BAC) on Thursday, and Morgan Stanley on Friday.  While Wall Street banks have endured several consecutive years of volatile results, they finally appear to be returning to profitability.  However, to the dismay of bank stock investors, bank valuation multiples are still restrained. 

The world got a sneak peak of Wall Street earnings with Wells Fargo (NYSE: WFC) reporting last week.  Wells Fargo seemed to provide solid results, reporting record fourth-quarter net income that handily beat earnings expectations.  Full-year net income was up 19 percent year over year.  Revenue for the fiscal year clocked in at over $86 billion, up 6 percent from the prior year.  And yet, the stock has sold off on the news.  Investors are still concerned with banks' low net interest margins--the interest rate difference between what a bank pays on its deposits and what it earns on its loans.  In a low-interest rate environment, it is especially difficult for banks like Wells Fargo, JP Morgan and Bank of America to earn high interest rate margins.   

It's Been a Wild and Bumpy Ride

Warren Buffett appeared on television last week to essentially guarantee the solvency of our nation’s banks.  Even though he is a well-publicized investor in Wells Fargo, it's unlikely that his endorsement will be enough to spur a rally in bank shares. 

Despite Wells Fargo's results, many banks have experienced problems over the last few years.  Last year, JPMorgan announced a huge $6.8 billion trading loss called the “London Whale.”  The stock went from $46 in early April to $30 two months later.  There was even media speculation of a cut to JP Morgan's dividend.  Since then, the bank's shares have recovered back to the mid-forties.  JP Morgan seems to be trading at a reasonable price-to-earnings ratio of 9.5, but the massive trading losses put a dent in the company's fourth quarter results.  The London Whale aside, the bank reported solid fourth quarter results: revenues rose 10% on the strength of a 33% increase in mortgage originations.  Earnings per share of $1.40 handily beat estimates of $1.16.  However, shares of JP Morgan didn't rally to the extent one would expect, and the bank still trades below book value.

Bank of America, meanwhile, has paid more than $50 billion in mortgage-related legal fees to settle disputes made against its subsidiary Countrywide, which it acquired just before the financial crisis.  These settlements caused the bank's fourth quarter earnings to shrink to 3 cents per share.  However, analyst expectations were for only 2 cents per share.  Revenues fell by more than 25% from the year-ago period.  Despite the earnings beat, Bank of America's shares are still at a fraction of what they were before the financial crisis.  Bank of America has barely been profitable over the last year and its dividend is still a token payout. 

What Will it Take for Valuation to Expand?

Better net interest margins would be hugely helpful for the banks. The spread on what the banks are earning through loans and what they pay on deposits is thin, dampened by both easy monetary policy from the Federal Reserve and a struggling economy. In order for valuation multiples, such as the price-to-book ratio, to expand, banks need to demonstrate a clearer return to stable profitability.

Another potential catalyst for a rally in the shares of America's biggest financial institutions might be a significant increase in their dividends.  For me, paying and raising dividends is one of, if not the, best ways a company can demonstrate that it is not only financially successful, but that it cares about its individual shareholders.  Given the volatilitile results banks have provided investors over the last few years, a dose of stable dividend increases may be necessary to instill investor confidence.

 


Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America, JPMorgan Chase & Co., and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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