How Did JP Morgan Really Do?

JPMorgan Chase (JPM) was the first of the major banks to report second quarter earnings and the headline figures were quite positive.  Quarterly profits rose 76% to $4.8 billion or $1.09 per share, and analysts’ expected the company to report just 70 cents per share.  The better performance was thanks in large part to slimmer loan losses and lower credit costs.  Furthermore, credit cards and retail banking both had long been a drag on JP Morgan’s performance actually both swung to a profit in the second quarter.  However, somewhat troubling was the fact that revenues actually dropped nearly 8 percent to $25.6 billion, as investment banking and trading revenue both sagged.  This drop in revenues was expected as the results were in-line with consensus analysts’ estimates.

So, JP Morgan, the nation’s second largest bank by assets, saw earnings soar while revenue declined sharply.  Sure, we know that credit conditions have improved, but even CEO Jamie Dimon said that delinquencies and charge-offs remained unacceptably high.  The factor that is going somewhat unnoticed is the fact that the company lowered their loan-loss reserves by $1.5 billion, which padded this quarter’s profits.  JP Morgan’s management team has been upfront about the reduction to reserves and warned that these results do not represent “normal ongoing earnings”.  However, the 23% reduction in reserves is a sign of confidence that current improving trends in credit will continue in the coming months.

At Ockham, our view of the quarter is mixed as trading revenues and fees from investment banking were rather anemic, yet credit concerns are easing to the point that they can take funds out of their reserves.  We recently upgraded JPM to Undervalued and we think the stock could easily increase by 20% based on current fundamentals.  For example, over the last ten years JPM has normally traded between 16.5x to 33.8x times cash earnings per share, but that is down to only about 12x at the current price.  Furthermore, the company trades at only 1.39x revenue per share, which compares favorably to the historically normal valuation of 1.49x to 2.50x.

JP Morgan has strengthened its balance sheet considerably and now has tier one capital of 12.1%, up from 9.7% at this time a year ago.  We would like to see management begin to ratchet up that dividend but at this point Mr. Dimon believes there are better uses of capital.  For example, the company bought back $500 million in stock and plans to continue to do that “opportunistically”.

Overall, we think this quarterly report was not a home-run, but JPM also did not strike out.  It was a solid base hit for the only major US bank that managed to not turn in a quarterly loss during the depths of the recession.  For value-oriented investors, we think that JP Morgan is among the most attractive stocks in the financial sector.  It is well run and we are finally starting to see better trends in consumer credit.  Furthermore, we expect that JPM will begin to increase the dividend back to more historically normal levels in the coming quarters.

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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