There are several investing codes by which I try to live. Aside from the fundamental principle of “buy low and sell high,” I also never underestimate the value of a strong balance sheet, especially when it is filled with well diversified businesses.
For this reason (among others) I never believed JPMorgan Chase ($JPM), which is still working to overcome a few embarrassments, was in any sort of prolonged danger. In fact, even with the bank’s disappointing April quarter, which angered some analysts, in the company’s defense I said the following:
The results of this quarter notwithstanding, JPMorgan still has a strong business in investment banking, mortgages and retail banking. If the bank can continue to produce solid return on equity in the low-to-mid single-digits coupled with a discount rate of 9.5%, fair value on the stock can reach $55. Plus, given the potential for share buybacks over the next several quarters, along with an improving balance sheet, investors can still get a 20% premium just by being patient.
I won’t disagree that the now-infamous London Whale trade has knocked some shine off JPMorgan’s armor. But in these situations Wall Street has always had a very short memory as long as companies apologize with higher revenue and profits. With the stock up 27% for the year to date and trading at around $55 per share, it’s safe to say that all is forgiven.
With the bank now producing fee income growth of more than 30%, there’s no question that when compared to Bank of America ($BAC) and Citigroup ($C), shares of JPMorgan are still undervalued.
What’s more, there are very few banks that can match JPMorgan’s performance in terms of profitability and credit quality. I’m not suggesting the bank has fully recovered from recent operational deficits. But the recent 13% revenue growth and the better-than-expected performance from its trading business suggest that some of the bigger problems are now in the rear-view mirror.
What’s more, I don’t believe it makes sense to continue discounting JPMorgan’s improvements in investment banking. Here again, while there still remains the risks from that side of the business, I can still appreciate that the bank is nonetheless making progress in other areas while it core business fully recovers.
The fact that overall lending has been weak across the entire sector is where JPMorgan’s well-diversified operation becomes an asset. Other businesses are picking up the slack while loan growth slowly improves. In that regard, let’s not pretend poor loan growth is just a JPMorgan-specific issue. That’s not the case at all. Sluggish loan growth has also impacted upon other well-managed banks such as Wells Fargo ($WFC) as well as several smaller regional banks such as BB&T ($BBT).
This makes the loan market highly competitive to the extent that loan pricing becomes the key differentiator among consumers. What this means is that the banks with better credit can offer better rates. Here, too, is where JPMorgan’s strong credit, which I referenced earlier, was extraordinarily important. Credit played a solid role in the bank’s ability to secure higher mortgage originations and auto loans, both of which grew by double-digit percentage points.
All of these positives aside, I’m not going to pretend JPMorgan is operating on all cylinders. The fact that there was a 27-basis-point year-over-year decline in net interest margin ($NIM) caused me a raise an eyebrow. NIM is the metric that tells investors if management made sound investment decisions relative to the bank’s debt situation.
Relative to what I’ve seen from other banks, 27 basis points is not a huge drop, especially considering that JPMorgan has been growing its earning assets. So I want to make sure that I keep this in perspective. But moving forward, this is a situation that bears watching.
Still, I don’t believe for a second that this changes anything about JPMorgan’s long-term growth prospects. Given the better-than-expected pace of its recovery, I can now see this stock reaching the $60 to $65 range by the end of the year.