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JPMorgan Earnings Preview — Expect a Hard Dose of Reality

JPM could take a hit if it's up front about European exposure

Large bank and financial services firm JPMorgan Chase (NYSE:JPM) reports earnings for the quarter ending Sept. 30 before the market opens Thursday. With the memory of 2008 fresh in their minds, investors have been selling shares of the company on any whiff of a cascading event such as a potential collapse in Europe.

Thursday’s JPM earnings report might do little more than to show investors that, at least for now, an accommodating Federal Reserve is allowing banks to print money and profits. What is less sure is whether the news will be enough to break the speculation of global calamity that has kept share prices in the banking sector clamped down.

The front and center issue is exposure to Europe. What sort of skeletons or derivative contracts are in the closet? What happens if there is a default in Europe? What is there to backstop the system during a massive failure?

JPMorgan has exceeded average Wall Street estimates in each of the past four quarters:

JPMorgan Chase

When JPMorgan last reported results, it beat expectations amid some of the same fears that exist today. The luster from that report did not last long, however — expectations for the current quarter have been slashed by Wall Street analysts. For the quarter ending Sept. 30, the current estimate is for JPM to make 96 cents per share; ninety days ago, the estimate was $1.19.

For the full year, the average Wall Street estimate calls for a profit of $4.69 per share. The expectation is for 12% growth in 2012 to $5.27 per share. At current prices, shares of JPM trade for seven times current-year estimated earnings.

JPMorgan Chase JPM
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It has been all downhill since JPMorgan peaked in February, with shares down 33% in that time. Share losses accelerated in July and have only recently bounced back after stocks in general bottomed last week.

The memory of the 2008 financial system collapse is fresh on the mind of investors. JPM shares are being penalized regardless of whether the risk of further asset reductions is real. At current prices, JPMorgan trades for just 0.72 times book value. Historically, that is a very cheap price — but not so cheap if the world is crumbling. Earnings matter little. If they did, JPMorgan would be an easy stock to buy given current valuation compared to expected profit growth.

There is no doubt that JPMorgan is exposed to Europe. What will be interesting in the current report is how the company values securities on its balance sheet. It would be reasonable to assume that earnings will miss significantly because of one-time write-downs — with cash flow from operations strong, now would be a good time to absorb those write-downs. The bank faces a delicate balancing act.

The bias here is for the company to release an ugly report. The knee-jerk reaction will be for the stock to decline, even if, for the long term, the news is not so bad. I would trade JPMorgan on the short side heading into Thursday.

But Europe appears to be kicking the can down the road, and JPMorgan would be wise to face the issue head-on with this report. I think JPM does just that.

As of this writing, Jamie Dlugosch did not own a position in any of the aforementioned stocks. His five keys to trading earnings can help you identify winning trades that can make big profits in a short period of time.

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