by Hilary Kramer | May 30, 2012 8:42 am
JPMorgan Chase (NYSE:JPM) became the latest black sheep of the banking sector this month after it revealed a single bad trade could cost the company upward of $2 billion in losses. Investors reacted to the news by dumping their shares, sending JPM down almost 10% in just one day following the announcement.
The real problem with the loss is not the dollar amount; a $2 billion hit is actually quite small in relation to the balance sheet and profitability of JPM. Instead, the issue lies in how it sideswiped investors, Wall Street and regulators. They immediately saw the mammoth financial institution presenting the loss as if it were a hedge against risk, when it really was a position taken to generate profit.
Politicians and industry analysts have been quick to cry “off with their heads!” and are pushing Congress to pass rigid regulations, like the Volcker Rule, to keep big banks in check. On May 14, the Justice Department opened an inquiry into the trading loss. Last week, the Securities and Exchange Commission began its own assessment of the loss, investigating the company’s accounting and disclosures to shareholders.
Fundamentally, JPMorgan’s trading blow-up has created heat from all sides, including Wall Street. The bank’s shares have been destroyed, falling from $41.23 on May 10 — the day that CEO Jamie Dimon gave his surprising emergency conference call to shareholders — to a low of $32.26 on May 21 before recovering slightly to its current $33.63.
JPM’s stock still is massively oversold, but it is no reflection on the health of the business. The company itself is strong and healthy — in fact, it’s thriving.
The takeaway here is this: Don’t buy the hype; buy JPM.
1. A $2 billion loss is not significant: This might be a tough one to swallow, but it is important to understanding why the stock still is viable. The trading loss JPM suffered is a principle transaction. In 2011, principle transactions accounted for only a little more than 10% of the company’s total revenues. The bottom line is that trading is not a major source of JPM’s revenues. Equally relevant is what the $2 billion loss actually means for JPM’s shareholders. A loss of this size equates to 52 cents per share pre-tax. Meanwhile, the company has a tangible book value of close to $35 per share pre-tax.
2. JPM’s business is sound — and growing: According to Wall Street estimates, JPM is expected to earn about $4 billion in Q2 2012, and that is with the $2 billion loss factored in. If the additional trading losses double, as some analysts forecast, JPM still has the potential to earn a $2 billion profit this year. Even without these profits, the trading loss is very manageable. That’s because JPM is a company that demonstrates strong resiliency under turmoil. In the wake of the 2008 financial crisis — a crisis that was due to the collapse of an underlying asset class (real estate) — the company reported $28.3 billion in pre-tax income. What JPM faces now is a single, poorly executed trade. It does not have the potential to evolve into the huge losses suffered during the 2008-09 financial crisis and global credit freeze.
3. The outlook for shareholders is getting better and better: A quick look at JPM’s technicals tells us that the stock still is strong. The company currently is trading below tangible book value, despite an approximate estimate of 13% ROTCE (Return on Average Tangible Common Shareholders’ Equity) for 2012. JPM also is near the bottom in terms of estimated 2012/2013 P/E, and its 3.7% dividend is more than double the average bank’s. Fundamentally, the company has created an entry point for its stock that provides a significant return, and it has been able to increase its dividend faster than rival banks because of stronger earnings and a more solid capital buffer.
4. Management is motivated by the stock’s performance: JPM consists of seasoned, smart, dedicated professionals who are motivated by their loyalty to the company and their interest in seeing the shares rally. A sizable percentage of management committee members’ compensation is paid in long-term stock incentives that can be clawed back if that person fails to make, or enters into, a risky position that compromises JPM. As for Jamie Dimon, he might have to leave the Fed board, but his tenure at JPM is guaranteed. The board is behind him, and so are investors — like me. This is an important insight into JPM’s company culture and a core factor that contributes to its overall strength, successes and — yes, I will say it — “a general culture of integrity.”
5. We’ve seen this before: I discussed a similar story with you last fall when investors thought Bank of America (NYSE:BAC) never would recover from the damage it suffered during the financial crisis. BAC fell out of favor with investors and its shares tanked. But I saw remarkable turnaround potential, and I was right. BAC shares rebounded and the stock became a solid investment once again. I see a similar story here — a beaten down stock with huge upside potential. JPM is one of the biggest players in its industry, and historically, one of the most respected among investors. It’s going to take a lot more than one bad trade to keep this powerhouse down.
I expect JPM to easily trade over $40 again. I couldn’t help but be struck by the irony that some are questioning whether Facebook (NASDAQ:FB), which traded over $40 only on its first day of trading, will see that level again anytime soon.
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