by Dan Burrows | May 15, 2012 6:30 am
High-level executive heads have rolled, the stock continues to fall and losses on a bad trade are expected to mount — but believe it or not, JPMorgan Chase (NYSE:JPM) still is a buy.
Yes, traders continued to pile out of the stock Monday amid the firm’s shocking revelation last week that it suffered a $2 billion-and-counting trading loss — a position JPMorgan maintains was a hedging strategy gone bad. Another $1 billion in losses are possible through the end of the year, the bank has said, so naturally Wall Street is discounting the stock for an even worse scenario.
As they say on the trading floor, there’s never just one cockroach.
JPMorgan’s stock has plunged more than 12% since the bank’s supercilious CEO Jamie Dimon dropped the news bomb, costing shareholders about $19 billion in market capitalization so far. For perspective, that’s more than the entire market value of ketchup maker H.J. Heinz (NYSE:HNZ).
But panic like we’re seeing in JPMorgan shares affords investors with longer horizons a rare advantage over traders whose holding times are now mostly measured in milliseconds. It’s a chance to buy on the sound of cannons, as the saying goes. When headlines and momentum become divorced from fundamentals, well, that’s often when you get shares on the cheap.
Take BP (NYSE:BP), for example. Two years ago, at the height of the oil spill crisis in the Gulf of Mexico, BP lost more than half its value. Little wonder there, given the uncertainty of the outcome and ultimate costs of the disaster. But just as ExxonMobil (NYSE:XOM) survived the Valdez tanker catastrophe (and the tobacco companies overcame a $200 billion legal settlement), BP didn’t die. Indeed, if you bought shares at the point of maximum panic in the summer of 2010, you’d be sitting on a gain of more than 50% by now.
True, JPMorgan’s reputation as the nation’s best-run bank has been tarnished, and it’s a huge, embarrassing blow to Dimon — both personally and in his quest to quash the Volcker rule and other new banking regulations. It’s also possible that further losses could balloon. Traders are harrowed by the thought, “If one trade blew up, what else is the bank sitting on?” It’s a cliche, but it’s true: Wall Street hates uncertainty, and that uncertainty — the fear of more cockroaches — is driving the selloff.
But even assuming additional losses double the total to $4 billion, as some reports suggest, the bank is sound and the drop in shares appears to have discounted the hit to earnings. Analysts’ average estimate for the current quarter has dropped to $1.02 a share from $1.05, according to data from Thomson Reuters. Furthermore, the Street still forecasts ample profits for the firm. Net income is expected to top more than $4 billion in each of the three remaining quarters of the year, good for profits of nearly $18 billion in fiscal 2012.
Some estimates are even higher and, more important, the bank’s self-proclaimed fortress balance sheet remains intact, analysts note.
“Given that we estimate JPM should earn around $5 billion each quarter this year, we believe this event could create earnings volatility, but it is not large enough to be a capital event,” writes Guggenheim analyst Marty Mosby. “Therefore, we do not expect capital positions to erode from current levels, rather, this event would only slow the improvement.”
If anything, investors should be aware that the selloff has JPMorgan trading at some compellingly cheap valuations. The stock offers discounts of more than 45% to its own five-year average on both a forward and trailing earnings basis, according to data from Thomson Reuters Stock Reports.
How cheap is that? The beating has gotten so bad that the market is now valuing JPMorgan on par with … wait for it … Citigroup (NYSE:C).
Whatever its current predicament, JPMorgan is no Citigroup. Dimon has cleaned house in the office responsible for the trading loss, and you can bet every position his traders hold is undergoing risk reassessment and intense scrutiny. The CEO was clearly humiliated by this fiasco — no nit will go unpicked in the bank’s books.
And, critically, the bank’s dividend and share buyback program remain in place. (If there’s a silver lining, this is a great time for JPMorgan to repurchase its own stock.) Also, Mosby notes that the loss recognized in JPMorgan’s position actually was created by a significant improvement in credit experienced over the first quarter of this year. That hardly suggests that the bank’s bad trade reflects an increase in systemic risk in the broader financial sector.
Dimon was wrong to dismiss initial reports about the trade as a tempest in a teapot, but that doesn’t mean the current storm in bank stocks and JPMorgan in particular isn’t overblown.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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