I hope that you all had a nice weekend. I just wanted to let you know that as our firm grows in size, we continue to leverage that with TD Ameritrade to get your costs lower. Options are only $1.25 per contract now, which is about a 17% discount from the $1.50 we were paying. Please be assured that we’ll continue to keep your costs as low as possible, as we are here to help protect and grow your hard-earned capital.
In addition, there was a well-written article in Barrons this weekend on J.P. Morgan and it relates to banking stocks in general. I also wrote this article last week:
We are much more heavily invested in Bank of America and Citigroup because the valuations are even better than J.P. Morgan but we like them all. The article makes a great point that I’ve been trying to emphasize. In an expensive market after 6 years of a bull market, the financials offer you the opportunity to buy the best franchises at discounts to a conservative estimate of liquidation value, while also providing some of the best dividend and earnings growth prospects. Not only do we own the stocks, but we have sold numerous put options expiring in the next year, which will either generate attractive income streams, or allow us an even cheaper entry-price into the stocks.
It is also important to note that we have been invested in these companies for 4 or 5 years now, depending on when you became a client. We’ve done well in them and we think that it is likely that the returns are likely to get much better over these next few years. Even if the general stock market doesn’t do great, we believe that these stocks can perform well. I’ve copied and pasted the article below because I know that not everyone has a WSJ/Barrons subscription. I hope that you enjoy. Thank you.
JPMorgan came out of the banking crisis stronger than it went in and it’s time for shares to catch-up. They could rise 30% in a year, not including the 2.9% yield.
March 28, 2015
After five years of leading JPMorgan Chase through epic regulatory struggles and legal settlements, Jamie Dimon has cemented his position as the world’s top banker. As other big banks floundered in the wake of the financial crisis, he used JPMorgan’s strong financial position to push to the fore in investment banking, credit cards, and asset management. And with some $2.6 trillion in assets, JPMorgan is the country’s largest bank.
The bank’s strengths should soon become visible in earnings, which could climb to $24 billion, or $6.50 a share, next year, from an expected $5.76 a share this year and $5.29 in 2014. Investors, however, have yet to catch on. At a recent price of $60, JPMorgan’s shares (ticker: JPM) are valued at just over 10 times this year’s earnings, one of the lowest price/earnings ratios among big U.S. banks. At an undemanding 12 times 2016 estimated earnings, the stock could approach $80 next year — a 30% gain. That still would be a steep discount to the Standard & Poor’s 500’s P/E of 16 times. Based on a recent dividend boost, to an annualized $1.76 a share, the stock yields 3%, tops among its peers.
The bank showcased its key businesses and management team at its annual investor day last month. CEO Dimon spent time trying to demolish the idea floating around in recent months that the bank might be better off in pieces. The breakup idea gained currency thanks to the bank’s low P/E and the notion that parts would carry a higher combined value than the whole, due in part to lower capital requirements.
Dimon countered that JPMorgan is an integrated company with four “unbelievable” franchises that derive $18 billion of annual revenue and cost benefits from being together. He added that the bank can absorb increased capital requirements and still deliver impressive returns and higher earnings.
“If there was a theme to investor day, it was Taylor Swift’s song, Shake It Off,” says Mike Mayo, a banking analyst at CLSA Securities. “The message to the regulators was: Throw at us what you will; we still can generate a 15% return on equity.” The bank’s return on tangible equity last year was 13%, and its goal is 15%.
“We were tried, tested, and true during the worst of times,” says JPMorgan’s Jamie Dimon. Photo: Jason Alden/Bloomberg News
First-quarter results due next month could be strong. One encouraging sign: The bank said in late February that its trading results since the start of the year were running ahead of last year’s pace. The consensus estimate is for $1.40 a share of net income, up from $1.28 a year ago.
Mayo added that the bank and Dimon have an “unstated goal: to become a national champion.” That’s not a label normally associated with big banks, given negative public perceptions and the massive charges for legal fees and regulatory settlements that the industry has taken in the past five years for a host of misdeeds leading to the 2008-09 mortgage crisis and other activities. Bernstein analyst John McDonald estimates the total charges at a stunning $123 billion for the largest banks since the crisis.
WHAT INVESTORS MAY NOT fully recognize is that JPMorgan has built several market-leading companies, including the country’s No. 1 credit-card company, based on outstanding loans; the No. 1 investment bank, by revenue; the top private bank; and the third-largest asset manager, behind BlackRock (BLK) and UBS Group (UBS). Dimon says that JPMorgan plays a vital role because multinational companies need a global bank for lending, foreign exchange, derivatives, underwriting services, cash management, among other services.
Mayo, a onetime JPMorgan skeptic who turned bullish in late 2014, carries a Buy rating and $70 price target. Street analysts like the bank, with 30 of 40 rating it a Buy and none carrying a Sell. “In addition to a discounted valuation, JPMorgan has adapted to the changing landscape, grown its market share, and reinvested back in the business,” says Barclays analyst Jason Goldberg, who rates it Outperform with a $73 price target.
“JPMorgan is a high-quality bank that has competitive advantages relative to everyone else. That should be worth a premium multiple,” says Ross Margolies, founder of Stelliam Investment Management, which holds JPMorgan shares. Dimon makes the same case, although he has said a premium valuation could take several years to obtain.
Current profits, moreover, may meaningfully understate its earnings power. At its investor day, JPMorgan laid out a bullish scenario in which it could earn $30 billion in 2017, up from $21.8 billion last year. That translates into $7.50 of earnings per share.
The $30 billion is based on a simulation, and thus isn’t a forecast. A key assumption is an increase in interest rates of more than two percentage points — something a cautious Federal Reserve may not undertake. However, some increase in rates is a good bet, and JPMorgan calculates that its profits will rise nearly $2.9 billion, or about 50 cents a share, for a one percentage point rise in rates.
The dividend, meanwhile, is likely to go higher over the next five years. Dimon said at investor day that the bank’s dividend-payout ratio (dividends divided by earnings per share), now about 30%, ultimately could get to 50% if regulators allow it. That might mean an eventual doubling in the dividend.
Dimon, 59, regularly talks about the bank’s “fortress balance sheet.” While that may be an overstatement, since the bank still has considerable financial leverage, JPMorgan’s capital base and ample liquidity make it one of the most formidable financial companies. A key capital ratio has doubled since the financial crisis.
At its investor day, the company produced a slide showing its resiliency over the past five years. It generated $97 billion in net income, despite $22 billion of after-tax legal expenses and $13 billion of regulatory and control costs, including the expense of adding 16,000 employees in recent years to deal with the bank’s regulatory and legal burden. Over that span, tangible book value grew to $44.69 a share from $27.09, an impressive 11% annualized increase.
No wonder that Dimon gets frustrated sometimes, telling reporters on a January call that banks are “under assault” from regulators. “We have five or six regulators or people coming after us on every different issue. It’s a hard thing to deal with.” At other times, he’s more conciliatory, saying last month, “Let’s get it done, no whining, set the highest standards, meet our regulatory commitments, and not make excuses.”
JPMorgan likely has dealt fully with the mortgage liability stemming from its own activities and those of companies it purchased during the financial crisis. Remaining legal costs probably stem from a foreign-exchange trading inquiry and the Libor rate-setting scandal. Bernstein’s McDonald estimates that JPMorgan will add $2.2 billion to its legal reserves this year, down from $11 billion at their peak in 2013.
SO WHY DOES JPMorgan trade so cheaply? For starters, investors want to see an end to a seemingly never-ending series of legal settlements and penalties. The entire group of mega-financials — Citigroup (C), Bank of America (BAC), Goldman Sachs (GS), and Morgan Stanley (MS) — trade for 10 to 12 times estimated 2015 earnings. Wells Fargo (WFC), which has a higher return on equity, commands a P/E of 13. The large financials could be one the biggest pockets of value in the stock market, where it’s tough to find any major group of stocks trading at close to 10 times earnings.
SOME INVESTORS VIEWJPMorgan as a black box — simply too big and complicated to understand. Dimon’s response is that the bank resembles a big regional in most of its activities and that the perceived trading and derivative risks at the investment bank are overblown. The bank doesn’t take big trading positions, he argues, focusing instead on generating profits from making markets on a large amount of customer activity. “We’re the Wal-Mart of fixed income,” Dimon told Barron’s. “We have huge economies of scale.”
The bank maintains that one scary figure — some $63 trillion in notional derivatives exposure — vastly overstates the risk because of offsetting positions and other factors. It puts the credit risk of those positions at about $59 billion, and almost 90% of that is exposure to high-grade companies.
The recent annual regulatory review of JPMorgan’s capital adequacy produced a mixed result. After the Comprehensive Capital Analysis and Review process, which involves a stress test seeking to measure banks’ ability to weather an economic downturn, JPMorgan was given the green light to lift its dividend by 10%, in line with expectations. However, it plans $6.4 billion of share repurchases over the next five quarters, below prior estimates of about $8 billion. The combined capital return — dividend and buybacks — is about 50% of earnings, below that of Wells Fargo, which is closer to 70%. Look for JPMorgan’s total payout ratio to go higher in the next few years. In the meantime, it should build plenty of capital.
“We were tried, tested, and true during the worst of times,” says Dimon. “We’ve built four outstanding franchises, each with great prospects. Legal and regulatory issues should abate over time.”
The four business units are consumer and community banking, corporate and investment banking, commercial banking, and asset management. The credit-card business, for instance, has been overhauled since 2008 to focus on more-affluent consumers, and the success of the bank’s upscale offerings, like Sapphire, and co-branded cards with the likes of United Airlines, account for some of the competitive pressure on American Express (AXP). JPMorgan even has a superhigh-end offering in its Palladium card that it believes is better than AmEx’s exclusive Centurion or Black card.
The corporate and investment bank is the industry leader in investment-banking revenues, which include advisory fees and underwriting revenues. It also sets the pace in controlling costs with employee compensation last year, accounting for just 30% of revenues, versus 37% for Goldman Sachs. There’s a growing moat around the business as global banks scale back or eliminate their trading operations.
Investors also get the services of Dimon, the country’s top banker and a champion of both JPMorgan and the industry, in a difficult political and regulatory environment. Mayo says Dimon could be “a character from a Hemingway novel, with all his bravado and hubris.” Dimon, who’s healthy after treatment for throat cancer last year, talks about staying another five years at the helm.
The outspoken Dimon can also come across as the smartest guy in the room, ruffling regulators and politicians. He brings experience, passion, strategic vision, and a familiarity with minute details of the bank’s vast operations. No major financial company is so closely identified with its leader.
The investor day also highlighted the bank’s bench amid concerns about CEO succession. Possible successors to Dimon include Marianne Lake, the chief financial officer; Matt Zames, the chief operating officer; Gordon Smith, the head of the consumer and community bank and former chief of the credit-card operations; and Mary Erdoes, the head of asset management. Dimon, like Berkshire Hathaway’s Warren Buffett, seems intent on leaving his company in such strong shape that his successor won’t need a commanding presence.
Dimon sees JPMorgan as a national asset, and that it would be a loss to the country if regulators ever force a breakup of the bank. “America has been the leader in global capital markets for the last 50 or 100 years,” he said on the January earnings call. “It’s part of the reason this country is so strong. I look at it as a matter of public policy. I wouldn’t want the next JPMorgan to be a Chinese company.”
U.S. bank regulators are concerned about the risks with the largest banks, and one result is that JPMorgan may need to carry the U.S. industry’s highest capital cushion to reflect its size and complexity. While final rules have yet to be set, JPMorgan might have to maintain by 2019 an 11.5% ratio of Common Equity Tier 1 to adjusted assets, 4.5 percentage points above the minimum of 7%. JPMorgan is the top U.S. bank in assets at $2.6 trillion, versus $2.1 trillion for Bank of America, $1.8 trillion for Citi, and $1.6 trillion for Wells Fargo.
JPMorgan is well on its way toward reaching that 11.5% capital goal, as its Tier 1 ratio stood at 10.2% at year-end 2014, double the 2007 level. It aims to hit 11% by the end of 2015 and 12% by 2018.
THE CAPITAL RULES ARE prompting JPMorgan to take a hard look at all of its businesses and activities to see whether they can stand up to the higher capital standards. It is moving to shed $100 billion of non-core deposits by the end of this year. JPMorgan is also telling hedge funds and other prime-brokerage clients to boost their business with the bank to justify the capital-heavy nature of their relationships.
Rivals like superregional U.S. Bancorp (USB) see opportunity because their simpler business model means lower required capital and thus an ability to underprice the giants on loans and still earn adequate returns.
Dimon is unfazed by the capital issue, saying the bank has long carried more capital and liquidity than its rivals and still maintained its competitiveness.
One of the chief complaints among big investors is the difficulty in finding good growth stocks in the current market. As a result, Facebook (FB), Under Armour (UA), and other fast-growing companies trade for lofty valuations. With a tail wind coming from higher rates, JPMorgan could emerge as an exciting growth story in the next few years, and it’s available now for just 10 times forward earnings.