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Cody Eustice
Cody Eustice
Articles (544)  | Author's Website |

Value Idea Contest: JPMorgan Still Undervalued

JPMorgan is one of the most profitable companies in the world

May 30, 2019 | About:

1. Company

JPMorgan Chase (NYSE:JPM) is one of the world largest banking institutions with $2.56 trillion in assets at the end of 2018. It has over 5,000 branches throughout the U.S., with 18,000 ATMs as well.

The JPMorgan of today is far different from the one founded by J.P. Morgan over 100 years ago. Over the last century, through mergers with Bank One, Bank of Manhattan, JP Morgan & Co, Bear Stearns and Washington Mutual, it has become one of the most dominant banking institutions in the world. Through one of these mergers, J.P. Morgan got one of the greatest bankers in modern history, Jamie Dimon. His leadership is one of the main reasons the company has become the largest bank in the U.S.

JPMorgan has excelled since the financial crisis of 2008 and is the second most profitable company behind Apple (AAPL).

2. JPMorgan history

JPMorgan & Co. was founded by legendary banker J.P. Morgan. His merchant bank was the most dominant of its time. During the banking crisis of 1908, Morgan was able to stabilize the markets, and his bank bailed out the U.S. Treasury when it didn't have enough gold supply. When his bank wasn't stabilizing the market or bailing out the government, it was a vehicle of consolidation throughout the nation's most important industries. The Morgan Way created General Electric and US Steel Corp., which are still around today. JPMorgan & Co continued to grow and expand its business even after J.P. Morgan passed away. In the 1930s the firm was forced by federal law to either be a commercial or investment bank, but it could not be both. JPMorgan decided to remain a commercial bank, giving up its securities business.

This led the bank to spin off its securities business into Morgan Stanley in 1935. In the 1950s, JPMorgan merged with Guaranty Trust Company of New York. After the merger, the combined bank did business as Morgan Guaranty Trust. Starting in the mid-1980s, the bank decided to move back to the JPMorgan brand through the merger with Purdue National. After that merger, JPMorgan was back and the bank continued to grow throughout the late 1980s and 1990s.

In 2004, JPMorgan merged with Bank One, which was led by Chairman and CEO Jamie Dimon. After the merger, Dimon became the chief operating officcer of JPMorgan. It was soon that Dimon made his presence know through cost cutting and replacing many JPMorgan executives with one from Bank One. In 2006, Dimon became CEO of JPMorgan and by the end of the year, he was chairman of the board.

JPMorgan continued to maintain a strong balance sheet and avoided the subprime loan markets, protecting the bank and shareholders. JPMorgan executives wanted to maintain prudence in banking, which played well for the firm when the financial crisis began. During the financial crisis, JPMorgan was forced to take bailout money from the Treasury and went on to acquire Bear Stearns and Washington Mutual with Treasury support. However, after the crisis was over and JP Morgan repaid the Treasury in full, the bank was hit with a lawsuit from the government for what Bear Stearns and Washington Mutual had done leading up to the financial crisis. This resulted in JPMorgan settling with the government, paying over $20 billion in fines.

During this time, the bank had to deal with the London Whale trader who lost $6 billion, leading to investigations and some fines. None of this fazed the bank or its leadership who kept leading the bank forward.

3. JPMorgan's financials

JPMorgan is the best of the best in the banking sector, seeing its earnings grow from $4.5 billion in 2004 to $32.5 billion in 2018. Earnings for the bank have increased by more than seven times and grown at an annual rate of 13.84%. During the same period, JPMorgan revenues grew from $43.09 billion to $109.09 billion in 2018. Revenues increased by more than 2.5 times from 2004 to 2018. Under Dimon's leadership, JPMorgan has become an economic powerhouse, out-earning all of its competitors.

The bank is a free cash flow machine, producing $14.1 billion in 2018. JPMorgan pays a dividend of $3.20 per share, or a 2.5% yield. Currently, the bank pays out 34.6% of its earnings in dividends annually. Simply, JPMorgan needs little capital to maintain its business and can increase its dividend annually and buy back shares from shareholders. In the first quarter, JPMorgan repurchased $4.7 billion in stock. When you add that to the dividend, JPMorgan returned $7.4 billion alone in the first quarter to shareholders. That equates to 80% of first-quarter earnings of $9.2 billion.

3.1 JPMorgan moat

Thanks to the financial crisis, JPMorgan has less competition, and the bank is larger and more dominant. It has a fortress balance sheet, which has only gotten better since the financial crisis. JPMorgan won't have to delever its balance sheet and has the financial flexibility to survive the next crisis. The leadership of Dimon and his management team ensures that JPMorgan will continue to thrive going forward.

4. Management

JPMorgan is run by some of the best bankers in the U.S. Dimon has spent his career in the banking sector and has a proven track record. Dimon grew Bank One into one of the largest banks in the U.S. until it merged with JPMorgan. He has been able to create an environment where the best of the best rise to the top. Dimon's management team is currently the best in the business. Many of Dimon's top executives have been poached for top positions at competitor banks.

5. JPMorgan valuation

Even after the massive run-up in JPMorgan's stock, it is still undervalued, trading at a discount to its intrinsic value. Currently, the bank trades at $108.23 a share, giving it a price-earnings ratio below 10. Over the last 10 years, JPMorgan has grown its earnings at an annual compound rate of 17.90%. That is a doozy of a growth rate for earnings for a bank as large as JPMorgan. JPMorgan will likely be able to grow its earnings at a rate of at least 5.5% going forward. This would put earnings per share at $15.71 in 10 years. Twelve times earnings would put JPMorgan's stock price at $188.52 per share.

Projecting earnings growth rates can be hard and unreliable However, JPMorgan has a proven track record of increasing earnings and producing steady earnings. We can use Warren Buffett (Trades, Portfolio)'s pretax earnings metric. JPMorgan's pretax earnings per share are $11.94. At 10 times pretax earnings, JPMorgan stock would trade for $119.40 per share. JPMorgan offers buyers a pretax earnings yield of 11.40%, which is far more than historic long-term interest rates. At 12 times pretax earnings, JPMorgan stock would be $142.80 per share.

JPMorgan will continue to buy back shares and increase its dividends annual to return capital to shareholders. This will lead to earnings growth with share reduction and increased dividend yield. JPMorgan is a great long-term investment, which will create great value for shareholders. In 10 years from now, JPMorgan will trade at a far higher price per share.

5.1 Risks

JPMorgan's interest revenues are highly dependent on interest rates and the yield spread between short-term loans from deposits and longer-term loans. As competitors try to compete with JPMorgan with better offers to consumers for their deposits,  it may see compressed spread margins. This could affect JPMorgan's profitability and erode its consumer base.

JPMorgan is particularly exposed to an economic recession. This would lead to higher loan defaults and little to no demand for new loans. But, JPMorgan can handle this as the bank keeps more than enough reserves to survive a financial crisis as bad or worse than 2008. During a downturn, the bank's earnings would erode.

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