My attitude on banking giant JPMorgan Chase (NYSE: JPM) can be summed up in what its second-quarter 2014 earnings report two weeks ago: both good and bad, rays of optimism but also some clouds on the horizon. In short, my view is that, while Wall Street is quite bullish on JPM, it’s not clear to me just how bright the stock’s prospects are after a five-year run of handy outperformance. So my call is “Hold”: don’t sell shares if you own them, but don’t buy if you don’t own any – at least not yet, in either case.
For some perspective, the stock closed today at $58.64, where it was trading at 14.5 times trailing 12-month earnings of $4.04. (It pays a dividend of $1.60, for a current yield of 2.73%, about the middle of the pack for the Dow 30.) But in March 2009, in the depths of the financial crisis, the stock bottomed out intraday at $13.40, so today’s price reflects an impressive comeback over the past five years or so. In fact, from 2009 through 2013, the stock generated an average total return (gains plus dividends) of 15.44% to the S&P 500’s 9.95%.
This year, though, the comparison hasn’t been in JPM’s favor. The stock did set a new all-time high of $60.27 in March, but year-to-date has returned just 2.27% to the S&P 500’s 7.62%. And that takes us back to the latest quarterly earnings.
Let’s start with the good in the July 15 announcement: JPM beat expectations, reporting $1.46 in second-quarter earnings per share, compared to the Street’s expected $1.31 (an 11.5% surprise). The figure was also higher than the first quarter’s $1.28, and marked the bank’s third consecutive quarter with rising earnings.
Now for the bad: the results for this second quarter were below the $1.60 the bank chalked up in the same quarter last year. That was slippage of 20%. Likewise, the figure for first quarter of this year was 19.6% below 1Q2013’s $1.59 a share.
If these were the only negatives, they would be worrisome enough, but in context they paint a somewhat more troubling picture. For one thing, in 2013 the bank’s total net income shrank almost 16% from $21.3 billion to $17.9 billion, which was still lower by 7% from 2012’s $19.0 billion. Full-year EPS shows the same pattern, with 2013’s $4.35 showing a 16% drop from 2012’s $5.20, and still lower than 2011’s $4.48.
The earnings down trend traces back to another weakness: a steady erosion in JPM’s net interest margin, from 3.12% for 2009 to just 2.23% last year. (Remember: banks make a profit by lending money at higher interest rates than they pay depositors). Return on equity has also eroded, from 11.0% in 2011 to 8.4% last year.
Finally, a look under the hood shows that since 2010, JPM has boosted earnings – by a considerable margin – every quarter by “releasing” loan loss reserves, to the tune of billions of dollars a year. After financial markets nearly froze shut in 2009, the banking industry was required to increase loan loss reserves by trillions of dollars, which created a great sucking sound out of profits.
Now that the crisis is over, loan portfolios have been cleaned and loan losses declined, banks have been taking billions out of those reserves and sending them right back to the bottom line. Last year alone, JPM released some $6 to 7 billion in reserves, equal to 35% to 40% of its net income for the year. With all of that Now, the bank’s remaining releasable reserves are nearly all gone, and, like so many other money center banks, JPM is going to have to go back to earning money the hard way.
In spite of all this, there is a lot going for JPM – it just depends on how optimistically you want to look at it all. First, the bank’s balance sheet is in tip-top shape, exceeding the standards put in place by regulators in the aftermath of the financial crisis. Second, the quality of its loan portfolio continues to improve (it added 10 cents to second quarter earnings).
Third, earnings were up nicely in several key businesses, like retail banking, commercial banking and asset management. And management is finally getting serious about cutting expenses, which essentially means trimming headcount and payroll. On top of it all, JPM is number one or two in terms of market share in most of it lines business, which include nearly every kind of banking business under the sun, from retail branch banking to mortgages, credit cards, commercial lending, investment banking and advisory, securities underwriting, trading and serving as a broker-dealer for US Treasurys. It’s one of the biggest global banks on the planet and one of the few you can call a “universal” bank.
All this translates to some healthy optimism on Wall Street, with Thomson Reuters noting that 25 of the 31 analysts who cover JPM rate it “Buy” or “Outperform”; five rate it a “Hold” and just one has a negative outlook, “Underperform.” The consensus is that for all of 2014, JPM will generate net profits of $5.50 a share, a whopping 26% improvement over last year. For 2015, though, the increase moderates to 8.4%, to $5.96 per share. And for the next five years, though, the consensus is that JPM’s earnings will grow just 4.5% per year. That’s just a fraction of the 25.0% it managed over the last five years, and it’s hard to see how the stock’s performance could stay on the pace it’s kept since 2009.
So here’s my projection for future JPM returns. I’m assuming that for the next five years JPM’s trailing PE ratio gears down to its 13-year median of 12.43. I’ll also assume that management will keep the yield steady by raising dividends as needed (not a guarantee by any means). That moves the stock to $68 by next March, $71 by Spring 2016, and topping out at $81.50 by early 2019. With dividends reinvested, that’s an average total return of about 10.8%.
That’s just fine for a “Hold”. But the projections are only as good as the analyst’s five-year estimates, and I see enough question marks to wait until I see how the next year or so pans out before recommending a “Buy.”
About Lawrence Meyers Larry is regarded as one of the nation’s experts on alternative consumer finance. He consults for hedge funds and private equity via his Council Member status at Gerson Lehman Group, and as a member of Coleman Research Group’s Executive Forum. He also consults for Credit Access Businesses and Credit Services Organizations in Texas. His Op-Eds and Letters to the Editor have appeared in over two dozen major newspapers. He also brokers financing, strategic investments, and distressed asset purchases between private equity firms and businesses of all stripes. You can reach him at [email protected]