Financial stocks certainly had a great year in 2012, gaining 25% throughout the year. Certain individual names did much better than that, such as Bank of America (BAC), rising from $5.75 to $12.03 throughout the year, for a remarkable gain of 109%. When a sector has a rally like this, investors need to seriously consider taking some of their gains off the table, as I would strongly recommend with Bank of America (the bearish case for BAC can be seen in this recent article of mine).
At the very least, investors need to pick their investments in financials a little more selectively going forward. With the exception of Citigroup (C), I believe most banks have had their day. Another breed of financials, the investment banks, looks a little more interesting to me. After considerable investigation into the matter, I believe the only investment bank to own for 2013 is JPMorgan Chase & Co. (JPM).
JPMorgan operates its business in 6 segments. This includes their very well-known Investment Bank segment (IB), and also other segments such as Retail Financial Services (RFS), which includes their commercial and business banking, as well as their Mortgage Production and Real Estate Portfolios. The Card Services and Auto (CSA) handles credit cards, while Treasury and Securities Services (TSS) provides investment and information services and has assets of $16.9 trillion. Commercial Banking (CB) provides lending and investment services to incorporated entities. Finally, the Asset Management (AM) segment provides investment management services to retail customers.
JPM is one of the few financial companies that emerged from the crisis of 2008-09 in considerably better shape than they went into it. Most notably, JPM acquired Bear Stearns for pennies on the dollar, giving the company a leading market share in the global prime brokerage business. In September of '08, JPM purchased all of the assets and only certain liabilities of Washington Mutual for $1.9 billion. Both of these purchases were very inexpensive compared to the market share they added to the company.
So, why do I believe JPM is the way to go, and not one of its competitors like Goldman Sachs (GS) or Morgan Stanley (MS)? For me, it is a matter of growth and valuation. When JPM reports fiscal year 2012 earnings in mid-January, consensus estimates call for the company to have earned $5.02 per share, up from $4.48 in 2011. This means JPM is already trading at an attractive P/E multiple of only 8.9 times current year earnings. With estimates calling for an 11% average earnings growth rate over the next three years, JPM's earnings growth certainly justifies this valuation and then some.
Comparatively, Goldman Sachs trades at 11.2 times 2012 earnings and is expected to grow its earnings by the same 11% annual rate as JPM. Also, worth noting is that JPM pays out a significantly greater dividend yield than GS, 2.78% to 1.57%. It is difficult to quote a P/E ratio for Morgan Stanley, as the consensus calls for negative earnings for 2012. For comparison purposes, let's assume the earnings projection of $1.98 is correct for FY 2013. This means that MS currently trades at 9.9 times forward earnings, which is a higher multiple than JPM trades to its current earnings. Additionally, MS only yields 1.05% as of this writing. It certainly appears that JPM is the most attractively valued of the three.
Now, in regard to what I expect from the stock over the next several years, I'm looking at a P/E ratio of 9.4, which is just under JPM's historical average (when you leave out the 2008-09 period). Assuming the 11% earnings growth rate is accurate; this would imply earnings of $6.19 per share for 2014. With my target valuation, this gives a projected share price of $58.19 at the end of 2014, or an annualized gain of over 14% for the next two years.