Thursday, May 24, 2012

Why JPM is Cheap?

I received the following comments on my previous JP Morgan (JPM) post.

"I'd love to hear a more in-depth value breakdown of investing in JPM. Its shares are still going down increasing the opportunity you mentioned."

Some quick JPM facts 

Here is the total earnings (in millions), earnings per share (EPS), and tangible book value (TBV) per share for JPM for the past 6 years. 

JPM EPS and TBVS















JPM earned $19 billion dollars last year $83 billion over the past six years.  On page two of the annual report the CEO, Jamie Dimon, states that in a more normal economy the company should earn between $22-24 billion per year.  This is a reasonable number and works out to around 1% on assets. 

Furthermore, the company's tangible book value per share was $33.69/shr at year end and $34.90/shr at end of the first quarter.  The company earned 15% on tangible equity in the first quarter.  Earnings were estimated to run about $19 billion this year or $5/shr before the announcement about the trading losses. 

On May 10th they announced a trading loss of $2 billion but I have seen some estimates believing it will be closer to $5 billion.  Thus, the loss amounts will amount to somewhere between one 1/8 to 1/4 of 2012 annual profit.  On a per share basis this loss amounts to somewhere between $0.50 to $1.30 per share.  While this is a large loss, the $26 billion in lost market cap is simply overblown.  This is a result of sentiment of the banking sector but this will likely change over the next 2-4 years. 

So, for the remainder of 2012 the company will earn somewhere between $3.70 to $4.50 per share.

JPM Derivative Losses

It should be noted that I commented on the derivative positions of JPM Here on December 3, 2011.  Here is the main quote from that post:

Many say banks are black boxes because of the removal of mark to market (FASB 157), which is not true. Mark to market still applies unless the market is illiquid or non existent. For BAC Level 3 assets (the ones marked to fantasy) are 2.9% of total assets and 4.8% of risk weighted assets (RWA).

Ironically, these are the best among the large US banks, including WFC, JPM, C. So when pundits toot their horn saying you can't believe the balance sheet, this is the part they are talking about. This brings me to my next point.

Many people claim that JPM has a rock solid balance sheet. This includes newspapers and the nut jobs running around over at seeking alpha that either post OR comment out of ignorance. Level 3 assets are 5.0% of total assets and 9.3% of risk weighted assets at JPM. That is enough to drive a truck through. They also have the largest notional amount of derivatives outstanding and the largest amount of trading assets. If anyone says JPM has a rock solid balance sheet (including Jamie Dimon), are talking their own book or don't know the facts. The only company with a rock solid balance sheet is Wells Fargo, the only one that didn't need TARP.


Why is JPM cheap?

The stock closed today at just below $34/shr so you can buy JPM at 9 times 2012 estimated profits, and 6.8 times estimated 2013 earnings.  For those who don't know how to invert a P/E ratio that equates to a 14.7% earnings yield for 2013.  I would be willing to bet that Buffett is buying JPM, either personally and/or for Berkshire Hathaway.

Secondly, if you read pages 37-39 of the annual shareholders letter Jamie Dimon spells out clearly why JPM is a bargain at tangible book value per share. 

Here are some notable quotes:

Why we bought back the stock and how we look at stock value

Our tangible book value per share is a good, very conservative measure of shareholder value.  If your assets and liabilities are properly valued, if your accounting is appropriately conservative, if you have real earnings without taking excessive risk and if you have strong franchises with defensible margins, tangible book value should be a very conservative measure of value.

The tables above show our earnings per share and tangible book value per share over the last six years. I’d like to make one last comment about our stock and your company. I view it as a great sign of strength that, in the worst financial markets since the Great Depression, your company could earn money, grow tangible book value, buy Bear Stearns and WaMu and expand our franchise.

Obviously Dimon has some egg on his face due to the excessive risk comment above but he is no amateur.  He know how to run a successful bank and he will clamp down on risks like these trading losses going forward. 

Conclusion

Obviously a few JPM traders screwed up big time but this loss is not terminal.  JPM does have a large derivative portfolio but most of this portfolio is interest rate swaps and other non-technical positions.  Given the large drop in the share price, you are now being offered very good upside with very little downside.  This loss is likely to be non-reoccurring. 

I know many people say the big banks will have to hold more capital after Basil III SIFI buffers are put in place, does it really matter if you can purchase the bank at a tangible book value.  By this I mean it matters more what your return on capital is than what the bank's ROE or ROTCE works out to be. 

Jamie Dimon is no idiot and will get this straightened out.  Buying at $34/shr gets you in the door at tangible book value and you will earn 11% on your money this year and 16% on your money in 2013 onward.  Also, the company is likely buying back shares right now at these depressed prices which will further increase EPS going forward.

As shown above the company is more than capable of earning $5/shr today.  As the banks begin to trade at more normal valuations and don't require any more capital for Basil III requirements, JPM will pay out around 50% of profits in dividends.  This equates to around $2.50/shr (capacity) as of today and the current payout is $1.20/shr (actual).  This means that the current dividend yield is 3.5% and they have the capacity to have a 7.4% yield at the current share price.  This is not some pie in the sky estimate but real figures based on what the company is currently earning.  The stock is cheap and at the current price JPM offers a very juicy current and potential dividend yield. 


Best Regards,
Kevin


Disclosure: I am long BRK.b, WFC, and BAC warrants (as of writing).  I may buy some JPM or JPM warrants and definitely would buy some if I didn't already have significant financial holdings.

2 comments:

  1. Great post. Thanks.

    Tom

    ReplyDelete
  2. It is finally good to understand why JMP is cheap.

    Ed Butowsky

    ReplyDelete