JP Morgan’s Stock and Fundamentals Still Don’t Jive
Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Warren Buffett once said about the world of business, “It takes 20 years to build a reputation and five minutes to ruin it.” For JPMorgan Chase (NYSE: JPM), although it was no glowing endorsement being once considered “the cleanest shirt in the dirty hamper,” it was a status that other banks wished they had.
After the embarrassment related to the “London Whale trade” it was all over. Still, management deserved credit for having acted quickly to mitigate the damage. For some investors however, JPMorgan’s recovery has appeared too slow. Consequently, the stock has not traded on fundamentals.
When compared to Bank of America (NYSE: BAC) and Citigroup (NYSE: C), which enjoy P/E ratios that are 3 times and 2 times that of JPMorgan’s, respectively, the stock is undervalued by at least 20%. However, after a solid Q4 the Street should appreciate that the upside is too great to ignore.
A Record Setting Q4 and End of Year
As impressive as JPMorgan’s profit performance was in Q3 – advancing 34% year-over-year – the bank managed to trump that mark as Q4 profits surged 53%. The bank said this was helped by strong mortgage banking and higher lending.
For the fourth quarter, analysts were expecting earnings to arrive at $1.20 per share on revenue of $24.46 billion, which would have represented 10% growth year-over-year. Impressively, JPMorgan posted net income of $5.7 billion or $1.39 per share. This compares favorably to the $3.7 billion or 90 cents per share in the year-ago quarter – EPS surged 54%.
The bank said that the results included several one-time items, including a pretax charge related to foreclosure settlements valued at $900 million. This is $256 million more than the $644 million paid by Wells Fargo (NYSE: WFC) as part of the $8.5 billion settlement related to the government-mandated review of foreclosures occurring at the height of the financial crisis.
Still, both pale in comparison to Bank of America, which said last week that it had mortgage-related settlements with Fannie Mae worth roughly $11.6 billion. Of that total, $1.8 billion were from sales of collection rights on home loans as BofA works to recover from its regrettable acquisition five years ago of Countrywide Financial.
However, JPMorgan’s portion of the payment clearly had little impact on its performance. The bank posted revenue of $24.4 billion, up 10% year-over-year. JPMorgan closed out 2012 with $21.3 billion in profits.
As noted, this is despite the roughly $6 billion loss related to the poor derivatives trade. The company’s CEO, Jamie Dimon, who was revealed to have had his 2012 salary cut in half to $11.5 million, had this to say about the bank’s record performance:
We continued to see favorable credit conditions across our wholesale loan portfolios and strong credit performance in our credit card portfolio, where charge-off rates remain at historic lows. The real estate portfolios, while at elevated levels of losses, continued to show improvement as the housing market and economy continued to recover. As a result, we reduced the related allowance for credit losses by $700 million in the fourth quarter and we are likely to continue to see reductions in the allowance as the environment improves.
All was not great, however, as trading revenues fell 15% sequentially. The bank attributed the decline (in part) to Hurricane Sandy and uncertainties related to the fiscal cliff. Likewise, the bank reported lower compensation in its investment banking segment, which fell 6% to $2.2 billion. Consequently, as a percentage of revenue, compensation dropped year-over-year to 33% from 34%.
As expected, mortgage banking remained solid with loan originations rising by 33% to $51.3 billion. On the other hand, this pales in comparison to Wells Fargo, which ended the year with $524 billion in residential mortgages.
As dominant as 2012 was for the financial sector, it certainly bodes well for investor confidence that JPMorgan was able to “kill it” in its performance. This follows a solid report from Wells Fargo, which recently beat on both top and bottom line estimates including a 24% jump in Q4 profit.
Citigroup will be next to report and investors will then get a good glimpse of what to expect from the sector in the coming quarters. For Citi, optimism is not as high as average estimates have dropped from $1.04 to 99 cents over the past three months. During that span, fiscal year estimates have also moved down 4% to $3.89 from $4.07.
In its recent quarter, that Citi was only able to produce 1% growth in loans means that Citi has been ceding market share to JPMorgan. However, and as noted, Citi still gets to enjoy a P/E of 18 versus JPMorgan’s P/E of 9. Some things still don’t make sense. Then again, some analysts have begun to realize this.
Recently, Goldman Sachs reiterated a buy rating on the stock while increasing the price target from $50 to $52. It’s worth noting however, that this followed Goldman Sachs opting to remove JPMorgan from its “conviction buy” list. Then again, what's more telling than raising a price target?
Analyst at Sterne Agee also upgraded JPMorgan to buy from neutral while raising its price target from $47 to $51. It is certainly an encouraging sign that prominent analysts continue to show such confidence. However, it's the bank’s recent execution that's been the cause for such bullishness.
It is clear that JPMorgan has a strong business and a solid franchise in investment banking, mortgages and retail banking. If the bank can continue to produce solid return on equity in the low to mid single digits (12.5%) coupled with a discount rate of 9.5%, there is no question that fair value on the stock should be around $58.
As I’ve been saying for while now, the stock remains undervalued by 20% and when coupled with the potential for share buybacks over the next several quarters and an improving balance sheet, this stock is not trading on fundamentals and may be the cheapest equity on the market.
rsaintvilus has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo & Company. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!